David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Boustead Holdings Berhad (KLSE:BSTEAD) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Boustead Holdings Berhad's Net Debt?
The image below, which you can click on for greater detail, shows that Boustead Holdings Berhad had debt of RM7.49b at the end of March 2021, a reduction from RM7.86b over a year. On the flip side, it has RM516.9m in cash leading to net debt of about RM6.98b.
How Strong Is Boustead Holdings Berhad's Balance Sheet?
We can see from the most recent balance sheet that Boustead Holdings Berhad had liabilities of RM7.81b falling due within a year, and liabilities of RM3.33b due beyond that. Offsetting these obligations, it had cash of RM516.9m as well as receivables valued at RM2.26b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM8.36b.
This deficit casts a shadow over the RM1.23b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Boustead Holdings Berhad would probably need a major re-capitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Weak interest cover of 1.4 times and a disturbingly high net debt to EBITDA ratio of 10.3 hit our confidence in Boustead Holdings Berhad like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. One redeeming factor for Boustead Holdings Berhad is that it turned last year's EBIT loss into a gain of RM430m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Boustead Holdings Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Boustead Holdings Berhad actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
On the face of it, Boustead Holdings Berhad's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Boustead Holdings Berhad has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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 2 warning signs for Boustead Holdings Berhad you should be aware of, and 1 of them is significant.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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