Johore Tin Berhad (KLSE:JOHOTIN) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Johore Tin Berhad (KLSE:JOHOTIN) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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.

Check out our latest analysis for Johore Tin Berhad

What Is Johore Tin Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Johore Tin Berhad had RM60.0m of debt, an increase on RM55.8m, over one year. However, it does have RM78.6m in cash offsetting this, leading to net cash of RM18.5m.

How Strong Is Johore Tin Berhad's Balance Sheet?

The latest balance sheet data shows that Johore Tin Berhad had liabilities of RM106.4m due within a year, and liabilities of RM8.81m falling due after that. Offsetting these obligations, it had cash of RM78.6m as well as receivables valued at RM108.6m due within 12 months. So it actually has RM71.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Johore Tin Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Johore Tin Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Johore Tin Berhad has increased its EBIT by 4.8% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Johore Tin 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. Johore Tin Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Johore Tin Berhad's free cash flow amounted to 39% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Johore Tin Berhad has RM18.5m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 4.8% in the last twelve months. So we don't think Johore Tin Berhad's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Johore Tin 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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