Is Stella Holdings Berhad (KLSE:STELLA) using too much debt?
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. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Stella Holdings Berhad (KLSE: STELLA) is in debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, 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 mercilessly liquidated by their bankers. 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. Of course, many companies use debt to finance their growth, without any negative consequences. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Our analysis indicates that STELLA is potentially overvalued!
What is Stella Holdings Berhad’s net debt?
As you can see below, at the end of June 2022, Stella Holdings Berhad had a debt of RM15.8 million, compared to RM10.5 million a year ago. Click on the image for more details. On the other hand, he has RM8.82 million in cash, resulting in a net debt of around RM6.96 million.
How strong is Stella Holdings Berhad’s balance sheet?
The latest balance sheet data shows that Stella Holdings Berhad had liabilities of RM38.1 million due within one year, and liabilities of RM20.0 million falling due thereafter. In return, he had RM8.82 million in cash and RM34.2 million in debt due within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (short term) by RM15.0 million.
While that might sound like a lot, it’s not that bad since Stella Holdings Berhad has a market capitalization of RM71.0 million, so it could probably bolster its balance sheet by raising capital if needed. However, it is always worth taking a close look at its ability to repay debt.
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.
Even though Stella Holdings Berhad’s debt is only 2.3, its interest coverage is really very low at 1.3. This leads us to wonder if the company is paying high interest because it is considered risky. Either way, it’s safe to say that the company has significant debt. Shareholders should know that Stella Holdings Berhad’s EBIT fell 36% last year. If this decline continues, it will be more difficult to repay debts than to sell foie gras at a vegan convention. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since Stella Holdings Berhad will need income to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three 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. That said, his ability to manage his total liabilities isn’t all that worrying. Overall, it seems to us that Stella Holdings Berhad’s balance sheet does pose a significant risk to the business. For this reason, we are quite cautious about the stock and believe shareholders should keep a close eye on its liquidity. 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 3 warning signs for Stella Holdings Berhad (1 is a bit obnoxious) you should be aware.
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.