Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Gagasan Nadi Cergas Berhad (KLSE:NADIBHD) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Gagasan Nadi Cergas Berhad
What Is Gagasan Nadi Cergas Berhad's Net Debt?
As you can see below, at the end of September 2021, Gagasan Nadi Cergas Berhad had RM306.8m of debt, up from RM286.8m a year ago. Click the image for more detail. However, because it has a cash reserve of RM56.9m, its net debt is less, at about RM249.9m.
How Strong Is Gagasan Nadi Cergas Berhad's Balance Sheet?
The latest balance sheet data shows that Gagasan Nadi Cergas Berhad had liabilities of RM106.1m due within a year, and liabilities of RM341.2m falling due after that. Offsetting this, it had RM56.9m in cash and RM150.8m in receivables that were due within 12 months. So it has liabilities totalling RM239.6m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of RM286.1m, so it does suggest shareholders should keep an eye on Gagasan Nadi Cergas Berhad's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Weak interest cover of 0.96 times and a disturbingly high net debt to EBITDA ratio of 17.7 hit our confidence in Gagasan Nadi Cergas Berhad like a one-two punch to the gut. The debt burden here is substantial. The silver lining is that Gagasan Nadi Cergas Berhad grew its EBIT by 270% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. 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 Gagasan Nadi Cergas 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Gagasan Nadi Cergas 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.
Our View
We weren't impressed with Gagasan Nadi Cergas Berhad's net debt to EBITDA, and its interest cover made us cautious. But its conversion of EBIT to free cash flow was significantly redeeming. When we consider all the factors mentioned above, we do feel a bit cautious about Gagasan Nadi Cergas Berhad's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Gagasan Nadi Cergas Berhad has 3 warning signs (and 2 which are potentially serious) we think 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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.
About KLSE:NADIBHD
Gagasan Nadi Cergas Berhad
An investment holding company, engages in the development of residential, commercial, and industrial property in Malaysia.
Excellent balance sheet and fair value.