Is Xin Hwa Holdings Berhad (KLSE:XINHWA) using too much debt?

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Xin Hwa Holdings Berhad (KLSE:XINHWA) uses debt. But does this debt worry shareholders?

When is debt a problem?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. 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.

Check out our latest analysis for Xin Hwa Holdings Berhad

What is the net debt of Xin Hwa Holdings Berhad?

The image below, which you can click on for more details, shows that Xin Hwa Holdings Berhad had debt of RM103.0 million at the end of December 2021, a reduction from RM132.7 million on a year. However, he also had RM15.2 million in cash, so his net debt is RM87.8 million.

KLSE: XINHWA Debt to Equity April 8, 2022

A Look at the Liabilities of Xin Hwa Holdings Berhad

The latest balance sheet data shows that Xin Hwa Holdings Berhad had liabilities of RM36.4 million due within one year, and liabilities of RM147.0 million falling due thereafter. On the other hand, it had cash of RM15.2 million and RM70.1 million of receivables due within one year. Thus, its liabilities outweigh the sum of its cash and receivables (short term) of RM98.0 million.

When you consider that this deficit exceeds the company’s market cap of RM77.2 million, you might be inclined to take a close look at the balance sheet. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Xin Hwa Holdings Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (5.8) and quite low interest coverage, as EBIT is only 1.6x interest charges. The debt burden here is considerable. Fortunately, Xin Hwa Holdings Berhad has grown its EBIT by 4.4% over the past year, slowly reducing debt to earnings. There is no doubt that we learn the most about debt from the balance sheet. But it is the earnings of Xin Hwa Holdings Berhad that will influence the balance sheet going forward. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.

Finally, a company can only repay its debts with cold hard cash, not with book profits. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Fortunately for all shareholders, Xin Hwa Holdings Berhad has actually produced more free cash flow than EBIT over the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our point of view

At first glance, Xin Hwa Holdings Berhad’s interest coverage left us hesitant on the stock, and its net debt to EBITDA was no more attractive than the single empty restaurant on the busiest night of the year. year. But at least it’s decent enough to convert EBIT to free cash flow; it’s encouraging. Looking at the balance sheet and taking all of these factors into account, we think the debt makes Xin Hwa Holdings Berhad stock a bit risky. Some people like that kind of risk, but we’re aware of the potential pitfalls, so we’d probably prefer it to take on less debt. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 4 warning signs for Xin Hwa Holdings Berhad (2 are a little nasty) you should be aware of.

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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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John A. Bogar