Is CAB Cakaran Corporation Berhad (KLSE:CAB) Using Too Much Debt?

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

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

View our latest analysis for CAB Cakaran Corporation Berhad

What Is CAB Cakaran Corporation Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 CAB Cakaran Corporation Berhad had debt of RM497.7m, up from RM435.0m in one year. However, it does have RM93.7m in cash offsetting this, leading to net debt of about RM404.1m.

How Strong Is CAB Cakaran Corporation Berhad's Balance Sheet?

According to the last reported balance sheet, CAB Cakaran Corporation Berhad had liabilities of RM476.5m due within 12 months, and liabilities of RM319.8m due beyond 12 months. Offsetting this, it had RM93.7m in cash and RM192.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM510.2m.

When you consider that this deficiency exceeds the company's RM372.6m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

CAB Cakaran Corporation Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (5.0), and fairly weak interest coverage, since EBIT is just 1.3 times the interest expense. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that CAB Cakaran Corporation Berhad actually grew its EBIT by a hefty 100%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since CAB Cakaran Corporation Berhad will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, CAB Cakaran Corporation Berhad burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both CAB Cakaran Corporation Berhad's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider CAB Cakaran Corporation Berhad to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 6 warning signs for CAB Cakaran Corporation Berhad you should be aware of, and 2 of them are significant.

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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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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