Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that AME Elite Consortium Berhad (KLSE:AME) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is AME Elite Consortium Berhad's Debt?
The image below, which you can click on for greater detail, shows that AME Elite Consortium Berhad had debt of RM271.7m at the end of December 2020, a reduction from RM319.3m over a year. But it also has RM287.3m in cash to offset that, meaning it has RM15.6m net cash.
How Healthy Is AME Elite Consortium Berhad's Balance Sheet?
We can see from the most recent balance sheet that AME Elite Consortium Berhad had liabilities of RM276.7m falling due within a year, and liabilities of RM274.2m due beyond that. Offsetting these obligations, it had cash of RM287.3m as well as receivables valued at RM113.0m due within 12 months. So it has liabilities totalling RM150.7m more than its cash and near-term receivables, combined.
Since publicly traded AME Elite Consortium Berhad shares are worth a total of RM922.6m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, AME Elite Consortium Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact AME Elite Consortium Berhad's saving grace is its low debt levels, because its EBIT has tanked 34% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if AME Elite Consortium Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. AME Elite Consortium Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, AME Elite Consortium Berhad's free cash flow amounted to 44% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While AME Elite Consortium Berhad does have more liabilities than liquid assets, it also has net cash of RM15.6m. So we don't have any problem with AME Elite Consortium Berhad's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for AME Elite Consortium Berhad you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
When trading stocks or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.