Is Jaycorp Berhad (KLSE:JAYCORP) 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.' 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. As with many other companies Jaycorp Berhad (KLSE:JAYCORP) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Jaycorp Berhad

How Much Debt Does Jaycorp Berhad Carry?

The image below, which you can click on for greater detail, shows that at July 2020 Jaycorp Berhad had debt of RM20.5m, up from RM12.2m in one year. But on the other hand it also has RM51.3m in cash, leading to a RM30.8m net cash position.

How Strong Is Jaycorp Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jaycorp Berhad had liabilities of RM57.7m due within 12 months and liabilities of RM16.9m due beyond that. Offsetting these obligations, it had cash of RM51.3m as well as receivables valued at RM46.5m due within 12 months. So it actually has RM23.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Jaycorp Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Jaycorp Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Jaycorp Berhad has seen its EBIT plunge 13% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is Jaycorp 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Jaycorp Berhad has net cash of RM30.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in RM22m. So we don't think Jaycorp Berhad's use of debt is risky. 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. For instance, we've identified 3 warning signs for Jaycorp Berhad that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.
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