These 4 Measures Indicate That YBS International Berhad (KLSE:YBS) Is Using Debt Reasonably Well

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that YBS International Berhad (KLSE:YBS) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for YBS International Berhad

What Is YBS International Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 YBS International Berhad had RM26.4m of debt, an increase on RM7.13m, over one year. However, because it has a cash reserve of RM10.8m, its net debt is less, at about RM15.7m.

How Strong Is YBS International Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that YBS International Berhad had liabilities of RM16.7m due within 12 months and liabilities of RM27.0m due beyond that. Offsetting this, it had RM10.8m in cash and RM14.3m in receivables that were due within 12 months. So its liabilities total RM18.7m more than the combination of its cash and short-term receivables.

YBS International Berhad has a market capitalization of RM78.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

YBS International Berhad's net debt of 2.2 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 7.2 times interest expense) certainly does not do anything to dispel this impression. Pleasingly, YBS International Berhad is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 146% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is YBS International 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, YBS International Berhad actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, YBS International Berhad's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, YBS International Berhad seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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 be aware of the 4 warning signs we've spotted with YBS International Berhad .

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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