David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 NTPM Holdings Berhad (KLSE:NTPM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is NTPM Holdings Berhad's Net Debt?
As you can see below, NTPM Holdings Berhad had RM345.1m of debt at April 2021, down from RM428.0m a year prior. However, because it has a cash reserve of RM51.5m, its net debt is less, at about RM293.6m.
How Strong Is NTPM Holdings Berhad's Balance Sheet?
The latest balance sheet data shows that NTPM Holdings Berhad had liabilities of RM414.6m due within a year, and liabilities of RM83.4m falling due after that. Offsetting this, it had RM51.5m in cash and RM142.5m in receivables that were due within 12 months. So it has liabilities totalling RM304.0m more than its cash and near-term receivables, combined.
This deficit isn't so bad because NTPM Holdings Berhad is worth RM539.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
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.
With a debt to EBITDA ratio of 2.4, NTPM Holdings Berhad uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 9.0 times its interest expenses harmonizes with that theme. Pleasingly, NTPM Holdings Berhad is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 109% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine NTPM Holdings Berhad's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, NTPM Holdings Berhad burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Neither NTPM Holdings Berhad's ability to convert EBIT to free cash flow nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to grow its EBIT with ease. We think that NTPM Holdings Berhad's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with NTPM Holdings Berhad , and understanding them should be part of your investment process.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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