Is Jaycorp Berhad (KLSE:JAYCORP) 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. We can see that Jaycorp Berhad (KLSE:JAYCORP) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Jaycorp Berhad

What Is Jaycorp Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of October 2021 Jaycorp Berhad had RM22.1m of debt, an increase on RM19.9m, over one year. However, its balance sheet shows it holds RM49.0m in cash, so it actually has RM27.0m net cash.

How Healthy Is Jaycorp Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jaycorp Berhad had liabilities of RM64.3m due within 12 months and liabilities of RM17.6m due beyond that. On the other hand, it had cash of RM49.0m and RM58.8m worth of receivables due within a year. So it actually has RM25.9m more liquid assets than total liabilities.

This surplus suggests that Jaycorp Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Jaycorp Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Jaycorp Berhad's load is not too heavy, because its EBIT was down 30% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Jaycorp Berhad will need earnings to service that debt. 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. While Jaycorp Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Jaycorp Berhad produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Jaycorp Berhad has RM27.0m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in RM9.5m. So we don't have any problem with Jaycorp Berhad's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Jaycorp Berhad that you should be aware of before investing here.

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.