Does Three-A Resources Berhad (KLSE:3A) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Three-A Resources Berhad (KLSE:3A) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Three-A Resources Berhad

What Is Three-A Resources Berhad's Net Debt?

As you can see below, Three-A Resources Berhad had RM12.2m of debt at March 2021, down from RM14.1m a year prior. But on the other hand it also has RM22.9m in cash, leading to a RM10.7m net cash position.

How Strong Is Three-A Resources Berhad's Balance Sheet?

The latest balance sheet data shows that Three-A Resources Berhad had liabilities of RM33.3m due within a year, and liabilities of RM20.9m falling due after that. On the other hand, it had cash of RM22.9m and RM110.5m worth of receivables due within a year. So it actually has RM79.3m more liquid assets than total liabilities.

This excess liquidity suggests that Three-A Resources Berhad is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Three-A Resources Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Three-A Resources Berhad has increased its EBIT by 4.5% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Three-A Resources Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Three-A Resources 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. In the last three years, Three-A Resources Berhad's free cash flow amounted to 29% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Three-A Resources Berhad has RM10.7m in net cash and a decent-looking balance sheet. And it also grew its EBIT by 4.5% over the last year. So we don't have any problem with Three-A Resources Berhad's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Three-A Resources Berhad that you should be aware of before investing here.

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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