Is Naim Holdings Berhad (KLSE:NAIM) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Naim Holdings Berhad (KLSE:NAIM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Naim Holdings Berhad

What Is Naim Holdings Berhad's Net Debt?

As you can see below, Naim Holdings Berhad had RM268.0m of debt at December 2021, down from RM313.8m a year prior. However, it does have RM298.4m in cash offsetting this, leading to net cash of RM30.3m.

A Look At Naim Holdings Berhad's Liabilities

According to the last reported balance sheet, Naim Holdings Berhad had liabilities of RM504.4m due within 12 months, and liabilities of RM90.6m due beyond 12 months. Offsetting this, it had RM298.4m in cash and RM174.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM122.4m.

This deficit isn't so bad because Naim Holdings Berhad is worth RM252.9m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Naim Holdings Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Naim Holdings Berhad if management cannot prevent a repeat of the 88% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Naim Holdings Berhad's earnings that will influence how the balance sheet holds up in the future. 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. 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. Happily for any shareholders, Naim Holdings Berhad actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While Naim Holdings Berhad does have more liabilities than liquid assets, it also has net cash of RM30.3m. And it impressed us with free cash flow of RM20m, being 284% of its EBIT. 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...

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.