Stella Holdings Berhad (KLSE:STELLA) has a somewhat strained balance sheet
Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We can see that Stella Holdings Berhad (KLSE: STELLA) uses debt in its business. But should shareholders worry about its use of debt?
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Stella Holdings Berhad
How much debt does Stella Holdings Berhad have?
You can click on the graph below for historical figures, but it shows that in December 2021, Stella Holdings Berhad had debt of RM14.5m, an increase of RM1.96m, on a year. On the other hand, he has RM4.32 million in cash, resulting in a net debt of around RM10.1 million.
How strong is Stella Holdings Berhad’s balance sheet?
According to the latest published balance sheet, Stella Holdings Berhad had liabilities of RM40.3 million due within 12 months and liabilities of RM1.68 million due beyond 12 months. As compensation for these obligations, it had cash of RM4.32 million and receivables valued at RM34.0 million due within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (short term) by RM3.66 million.
Given that publicly traded shares of Stella Holdings Berhad are worth a total of RM66.3 million, it seems unlikely that this level of liability is a major threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
With a debt to EBITDA ratio of 2.5, Stella Holdings Berhad uses debt wisely but responsibly. And the attractive interest coverage (EBIT of 9.6 times interest expense) certainly makes do not do everything to dispel this impression. Shareholders should know that Stella Holdings Berhad’s EBIT fell 20% last year. If this decline continues, it will be more difficult to repay debts than to sell foie gras at a vegan convention. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since Stella Holdings Berhad will need income to repay this debt. 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. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past two years, Stella Holdings Berhad has experienced substantial negative free cash flow, in total. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
At first glance, Stella Holdings Berhad’s EBIT to free cash flow conversion left us hesitant about the stock, and its EBIT growth rate was no more attractive than the single empty restaurant la busiest night of the year. But at least it’s decent enough to cover its interest costs with its EBIT; it’s encouraging. Looking at the balance sheet and taking all of these factors into account, we think debt makes Stella 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. 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 outside of the balance sheet. For example, we have identified 4 warning signs for Stella Holdings Berhad (1 is significant) which you should be aware of.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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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.