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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Analabs Resources Berhad (KLSE:ANALABS) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Analabs Resources Berhad Carry?
As you can see below, at the end of October 2021, Analabs Resources Berhad had RM77.2m of debt, up from RM37.1m a year ago. Click the image for more detail. However, it also had RM30.4m in cash, and so its net debt is RM46.8m.
How Strong Is Analabs Resources Berhad's Balance Sheet?
The latest balance sheet data shows that Analabs Resources Berhad had liabilities of RM91.4m due within a year, and liabilities of RM34.7m falling due after that. On the other hand, it had cash of RM30.4m and RM28.8m worth of receivables due within a year. So it has liabilities totalling RM66.9m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Analabs Resources Berhad has a market capitalization of RM150.3m, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
We'd say that Analabs Resources Berhad's moderate net debt to EBITDA ratio ( being 1.9), indicates prudence when it comes to debt. And its commanding EBIT of 1k times its interest expense, implies the debt load is as light as a peacock feather. Pleasingly, Analabs Resources Berhad is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 170% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Analabs Resources Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
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. Happily for any shareholders, Analabs Resources Berhad actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
The good news is that Analabs Resources Berhad's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its level of total liabilities does undermine this impression a bit. Zooming out, Analabs Resources Berhad seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. Be aware that Analabs Resources Berhad is showing 1 warning sign in our investment analysis , you should know about...
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.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.