Is Asia File Corporation Bhd (KLSE:ASIAFLE) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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, Asia File Corporation Bhd. (KLSE:ASIAFLE) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Asia File Corporation Bhd

What Is Asia File Corporation Bhd's Net Debt?

The image below, which you can click on for greater detail, shows that Asia File Corporation Bhd had debt of RM22.7m at the end of September 2020, a reduction from RM28.6m over a year. However, it does have RM269.8m in cash offsetting this, leading to net cash of RM247.1m.

A Look At Asia File Corporation Bhd's Liabilities

We can see from the most recent balance sheet that Asia File Corporation Bhd had liabilities of RM50.1m falling due within a year, and liabilities of RM16.9m due beyond that. Offsetting these obligations, it had cash of RM269.8m as well as receivables valued at RM48.8m due within 12 months. So it can boast RM251.7m more liquid assets than total liabilities.

This surplus strongly suggests that Asia File Corporation Bhd has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Asia File Corporation Bhd has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Asia File Corporation Bhd has increased its EBIT by 6.3% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Asia File Corporation Bhd'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Asia File Corporation Bhd 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 three years, Asia File Corporation Bhd 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

While it is always sensible to investigate a company's debt, in this case Asia File Corporation Bhd has RM247.1m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of RM46m, being 117% of its EBIT. When it comes to Asia File Corporation Bhd's debt, we sufficiently relaxed that our mind turns to the jacuzzi. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Asia File Corporation Bhd that you should be aware of.

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.

When trading Asia File Corporation Bhd or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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