Is Naim Holdings Berhad (KLSE:NAIM) A Risky Investment?

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. Importantly, Naim Holdings Berhad (KLSE:NAIM) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Naim Holdings Berhad

How Much Debt Does Naim Holdings Berhad Carry?

The image below, which you can click on for greater detail, shows that Naim Holdings Berhad had debt of RM293.4m at the end of June 2021, a reduction from RM456.5m over a year. But it also has RM334.4m in cash to offset that, meaning it has RM41.0m net cash.

A Look At Naim Holdings Berhad's Liabilities

The latest balance sheet data shows that Naim Holdings Berhad had liabilities of RM514.3m due within a year, and liabilities of RM104.0m falling due after that. On the other hand, it had cash of RM334.4m and RM142.1m worth of receivables due within a year. So its liabilities total RM141.8m more than the combination of its cash and short-term receivables.

Naim Holdings Berhad has a market capitalization of RM343.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Naim Holdings Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Naim Holdings Berhad made a loss at the EBIT level, last year, it was also good to see that it generated RM123m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Naim 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. Naim Holdings 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. Over the last year, Naim 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.

Summing up

Although Naim Holdings Berhad's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of RM41.0m. The cherry on top was that in converted 288% of that EBIT to free cash flow, bringing in RM353m. So we are not troubled with Naim Holdings Berhad's debt use. 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. Be aware that Naim Holdings Berhad is showing 2 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.