Health Check: How Prudently Does Ajiya Berhad (KLSE:AJIYA) Use Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Ajiya Berhad (KLSE:AJIYA) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ajiya Berhad

What Is Ajiya Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of August 2020 Ajiya Berhad had RM7.69m of debt, an increase on RM594.0k, over one year. But it also has RM131.1m in cash to offset that, meaning it has RM123.4m net cash.

How Strong Is Ajiya Berhad's Balance Sheet?

According to the last reported balance sheet, Ajiya Berhad had liabilities of RM44.7m due within 12 months, and liabilities of RM9.34m due beyond 12 months. On the other hand, it had cash of RM131.1m and RM82.8m worth of receivables due within a year. So it actually has RM159.9m more liquid assets than total liabilities.

This luscious liquidity implies that Ajiya Berhad's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Ajiya Berhad has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Ajiya Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Ajiya Berhad had a loss before interest and tax, and actually shrunk its revenue by 24%, to RM256m. That makes us nervous, to say the least.

So How Risky Is Ajiya Berhad?

Although Ajiya Berhad had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of RM2.4m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. The next few years will be important as the business matures. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Ajiya Berhad you should be aware of, and 1 of them is a bit unpleasant.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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