These 4 Measures Indicate That Gagasan Nadi Cergas Berhad (KLSE:NADIBHD) Is Using Debt Extensively

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. We can see that Gagasan Nadi Cergas Berhad (KLSE:NADIBHD) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Gagasan Nadi Cergas Berhad

How Much Debt Does Gagasan Nadi Cergas Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that Gagasan Nadi Cergas Berhad had RM286.8m of debt in September 2020, down from RM323.1m, one year before. However, because it has a cash reserve of RM68.6m, its net debt is less, at about RM218.2m.

How Strong Is Gagasan Nadi Cergas Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gagasan Nadi Cergas Berhad had liabilities of RM119.2m due within 12 months and liabilities of RM332.6m due beyond that. On the other hand, it had cash of RM68.6m and RM115.7m worth of receivables due within a year. So its liabilities total RM267.5m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of RM203.3m, we think shareholders really should watch Gagasan Nadi Cergas Berhad's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.26 times and a disturbingly high net debt to EBITDA ratio of 45.9 hit our confidence in Gagasan Nadi Cergas Berhad like a one-two punch to the gut. The debt burden here is substantial. Worse, Gagasan Nadi Cergas Berhad's EBIT was down 87% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Gagasan Nadi Cergas Berhad will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Gagasan Nadi Cergas Berhad actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

To be frank both Gagasan Nadi Cergas Berhad's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, it seems to us that Gagasan Nadi Cergas Berhad's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 5 warning signs we've spotted with Gagasan Nadi Cergas Berhad (including 2 which is don't sit too well with us) .

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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