These 4 Measures Indicate That Berjaya Assets Berhad (KLSE:BJASSET) Is Using Debt Extensively

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Berjaya Assets Berhad (KLSE:BJASSET) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Berjaya Assets Berhad

How Much Debt Does Berjaya Assets Berhad Carry?

As you can see below, Berjaya Assets Berhad had RM754.1m of debt at September 2020, down from RM790.9m a year prior. However, it also had RM53.3m in cash, and so its net debt is RM700.8m.

A Look At Berjaya Assets Berhad's Liabilities

According to the last reported balance sheet, Berjaya Assets Berhad had liabilities of RM295.2m due within 12 months, and liabilities of RM973.7m due beyond 12 months. Offsetting these obligations, it had cash of RM53.3m as well as receivables valued at RM58.1m due within 12 months. So its liabilities total RM1.16b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's RM1.15b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.69 times and a disturbingly high net debt to EBITDA ratio of 11.4 hit our confidence in Berjaya Assets Berhad like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Berjaya Assets Berhad saw its EBIT tank 28% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But it is Berjaya Assets 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Berjaya Assets Berhad recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

To be frank both Berjaya Assets Berhad's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, it seems to us that Berjaya Assets Berhad's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Take risks, for example - Berjaya Assets Berhad has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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