Is Zelan Berhad (KLSE: ZELAN) using too much debt?

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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” It is only natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. We notice that Zelan Berhad (KLSE: ZELAN) has debt on its balance sheet. But the real question is whether this debt makes the business risky.

What risk does debt entail?

Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. 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) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, many companies use debt to finance their growth without negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.

See our latest review for Zelan Berhad

How much debt does Zelan Berhad carry?

You can click on the graph below for the historical figures, but it shows that Zelan Berhad had a debt of RM 509.6 million in September 2021, up from RM 537.5 million a year earlier. Net debt is about the same because it doesn’t have a lot of cash.

KLSE: ZELAN History of debt to equity January 12, 2022

How strong is Zelan Berhad’s balance sheet?

We can see from the most recent balance sheet that Zelan Berhad had a liability of RM 280.4 million due within one year and a liability of RM 489.0 million due beyond. In compensation for these obligations, he had cash of RM 5.90 million as well as receivables valued at RM 108.5 million due within 12 months. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by RM 655.0 million.

This deficit casts a shadow over RM80.3m society, like a colossus towering over mere mortals. We therefore believe that shareholders should monitor it closely. In the end, Zelan Berhad would likely need a major recapitalization if his creditors demanded repayment.

We measure a company’s indebtedness relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). Thus, we look at debt versus earnings with and without amortization expenses.

It turns out that Zelan Berhad has a rather worrying net debt to EBITDA ratio of 9.1 but very strong interest coverage of 10.6. So either he has access to very cheap long-term debt or his interest charges will go up! Fortunately, Zelan Berhad is increasing his EBIT faster than former Australian Prime Minister Bob Hawke, posting a gain of 213% over the past twelve months. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in isolation; since Zelan Berhad will need income to repay this debt. So if you want to know more about its profits, it may be worth checking out this long term profit trend chart.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We must therefore clearly examine whether this EBIT leads to the corresponding free cash flow. Over the past three years, Zelan Berhad has actually generated more free cash flow than EBIT. This kind of cash conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.

Our point of view

We feel some trepidation about the difficulty level of Zelan Berhad’s Total Passive, but we also have some positives to focus on. Its conversion from EBIT to free cash flow and the growth rate of EBIT were encouraging signs. From all the angles mentioned above, it seems to us that Zelan Berhad is a somewhat risky investment because of its debt. This isn’t necessarily a bad thing, as leverage can increase returns on equity, but it’s something to be aware of. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks lie on the balance sheet – far from it. For example, Zelan Berhad has 3 warning signs (and 1 which is significant) we think you should be aware of.

At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.

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