Three-A Resources Berhad (KLSE:3A) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Three-A Resources Berhad (KLSE:3A) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Three-A Resources Berhad

What Is Three-A Resources Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that Three-A Resources Berhad had RM13.2m of debt in September 2020, down from RM15.1m, one year before. However, it does have RM34.7m in cash offsetting this, leading to net cash of RM21.6m.

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

We can see from the most recent balance sheet that Three-A Resources Berhad had liabilities of RM37.9m falling due within a year, and liabilities of RM26.7m due beyond that. Offsetting this, it had RM34.7m in cash and RM109.1m in receivables that were due within 12 months. So it actually has RM79.3m more liquid assets than total liabilities.

It's good to see that Three-A Resources Berhad has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. 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.

Also good is that Three-A Resources Berhad grew its EBIT at 20% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Three-A Resources Berhad's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. Over the last three years, Three-A Resources Berhad reported free cash flow worth 13% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Three-A Resources Berhad has RM21.6m in net cash and a decent-looking balance sheet. And we liked the look of last year's 20% year-on-year EBIT growth. So we don't think Three-A Resources 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. Take risks, for example - Three-A Resources Berhad has 1 warning sign we think 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.

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