David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that Sime Darby Berhad (KLSE: SIME) uses debt in its business. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Sime Darby Berhad
What is Sime Darby Berhad’s debt?
You can click on the graph below for historical figures, but it shows that in December 2021, Sime Darby Berhad had RM2.22 billion in debt, an increase from RM1.33 billion, on a year. However, he has RM2.05 billion in cash to offset this, resulting in a net debt of around RM164.0 million.
How strong is Sime Darby Berhad’s balance sheet?
The latest balance sheet data shows that Sime Darby Berhad had liabilities of RM9.88b due within a year, and liabilities of RM2.70b falling due thereafter. As compensation for these obligations, it had cash of RM2.05 billion as well as receivables valued at RM4.76 billion and due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by RM5.77 billion.
Sime Darby Berhad has a market capitalization of RM16.7 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. But it is clear that it must be carefully examined whether he can manage his debt without dilution. Either way, Sime Darby Berhad has next to no net debt, so it’s fair to say she’s not heavily in debt!
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Sime Darby Berhad has virtually no net debt as evidenced by its net debt to EBITDA ratio of just 0.07. Humorously, he actually received more interest in the last twelve months than he had to pay. So there’s no doubt that this company can go into debt as easily as enthusiastic self-tanners take on an orange hue. And we also warmly note that Sime Darby Berhad increased its EBIT by 17% last year, which makes its debt more manageable. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Sime Darby Berhad’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Sime Darby Berhad has actually produced more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
The good news is that Sime Darby Berhad’s demonstrated ability to cover his interest costs with his EBIT delights us like a fluffy puppy does a toddler. And this is only the beginning of good news since its conversion of EBIT into free cash flow is also very pleasing. Overall, we think Sime Darby Berhad’s use of debt seems entirely reasonable and we’re not worried about that. After all, reasonable leverage can increase return on equity. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Know that Sime Darby Berhad shows 1 warning sign in our investment analysis you should know…
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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