Is Hubline Berhad (KLSE: HUBLINE) a risky investment?
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We can see that Hubline Berhad (KLSE: HUBLINE) uses debt in its business. But the most important question is: what risk does this debt create?
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we look at debt levels, we first look at cash and debt levels, together.
See our latest review for Hubline Berhad
What is Hubline Berhad’s net debt?
The graph below, which you can click for more details, shows that Hubline Berhad had a debt of RM 77.3 million in June 2021; about the same as the year before. However, he also had RM16.6 million in cash, so his net debt is RM60.7 million.
A look at the responsibilities of Hubline Berhad
Zooming in on the latest balance sheet data, we can see that Hubline Berhad had liabilities of RM 89.1 million due within 12 months and RM 59.1 million liabilities due beyond. In compensation for these obligations, he had cash of RM16.6 million as well as receivables valued at RM31.8 million maturing within 12 months. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by RM99.8 million.
This is a mountain of leverage compared to its market cap of RM 150.1 million. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (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 1.9, Hubline Berhad uses debt smartly but responsibly. And the fact that her last twelve months of EBIT was 9.0 times her interest expense ties in with that theme. Notably, Hubline Berhad recorded a loss in EBIT level last year, but improved it to achieve positive EBIT of RM14 million in the last twelve months. There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of Hubline Berhad that will influence the balance sheet in the future. So, if you want to know more about its profits, it may be worth checking out this chart of its long term profit trend.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Considering the past year, Hubline Berhad actually had a cash outflow, overall. Debt is typically more expensive and almost always riskier in the hands of a business with negative free cash flow. Shareholders should hope for improvement.
Our point of view
Reflecting on Hubline Berhad’s attempt to convert EBIT into free cash flow, we are certainly not enthusiastic. But on the bright side, his interest coverage is a good sign and makes us more optimistic. Looking at the balance sheet and taking all of these factors into account, we think debt makes Hubline Berhad stock a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 5 warning signs for Hubline Berhad (2 of which are potentially serious!) that you should be aware of.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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