Warren Buffett said: “Volatility is far from synonymous with risk”. So it seems like smart money knows that debt – which is usually linked to bankruptcies – is a very important factor when you assess the risk of a business. We notice that Quick Synergy Berhad (KLSE: FAST) has debts on its balance sheet. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap stock price just to get its debt under control. Of course, many companies use debt to finance growth without any negative consequences. When we look at debt levels, we first look at cash and debt levels, together.
How much debt is Rapid Synergy Berhad?
The image below, which you can click for more details, shows that as of December 2020, Rapid Synergy Berhad had a debt of RM 172.2 million, compared to RM 156.8 million in one year. However, he also had RM10.6million in cash, so his net debt is RM161.5million.
A look at the responsibilities of Rapid Synergy Berhad
The latest balance sheet data shows that Rapid Synergy Berhad had liabilities of RM 46.5 million due one year and liabilities of RM 139.1 million due thereafter. On the other hand, he had a cash position of RM 10.6 million and RM 13.6 million of receivables due within one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of RM161.4 million.
This deficit is not that big as Rapid Synergy Berhad is worth 748.3 million RM, and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky.
In order to size a company’s debt relative to its profit, we calculate its net debt divided by its profit before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and tax (EBIT) divided by its interest expense. (its interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
Low interest coverage of 1.2 times and an extremely high net debt to EBITDA ratio of 10.5 hurt our confidence in Rapid Synergy Berhad as a gut boost. This means that we consider him to be in heavy debt. Worse yet, Rapid Synergy Berhad’s EBIT is down 34% from last year. If the profits continue like this for the long haul, it has an incredible chance to pay off that debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is the benefits of Rapid Synergy Berhad that will influence the performance of the balance sheet in the future. So when you consider debt, it’s really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, while the tax authorities love accounting profits, lenders only accept cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Rapid Synergy Berhad has actually produced more free cash flow than EBIT. There is nothing better than receiving cash to stay in the good favor of your lenders.
Our point of view
Neither Rapid Synergy Berhad’s ability to grow its EBIT nor its interest coverage gave us confidence in its ability to take on more debt. But the good news is that it seems to be able to easily convert EBIT into free cash flow. Taking the above factors together, we believe that Rapid Synergy Berhad’s debt presents certain risks to the business. While this debt can increase returns, we believe the company now has sufficient leverage. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 2 warning signs for Rapid Synergy Berhad (1 cannot be ignored!) Which you should be aware of before investing here.
If you want to invest in companies that can generate profits without the burden of debt, take a look at this free list of growing companies that have net cash on the balance sheet.
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