Ann Joo Resources Berhad (KLSE:ANNJOO) Has A Somewhat Strained Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Ann Joo Resources Berhad (KLSE:ANNJOO) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Ann Joo Resources Berhad

What Is Ann Joo Resources Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that Ann Joo Resources Berhad had RM1.06b of debt in March 2021, down from RM1.12b, one year before. However, because it has a cash reserve of RM94.2m, its net debt is less, at about RM963.7m.

A Look At Ann Joo Resources Berhad's Liabilities

The latest balance sheet data shows that Ann Joo Resources Berhad had liabilities of RM1.23b due within a year, and liabilities of RM69.8m falling due after that. Offsetting these obligations, it had cash of RM94.2m as well as receivables valued at RM503.8m due within 12 months. So its liabilities total RM706.0m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Ann Joo Resources Berhad is worth RM1.19b, 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 measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 8.8 hit our confidence in Ann Joo Resources Berhad like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. One redeeming factor for Ann Joo Resources Berhad is that it turned last year's EBIT loss into a gain of RM51m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Ann Joo Resources 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Ann Joo Resources Berhad actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Ann Joo Resources Berhad's net debt to EBITDA and interest cover definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Ann Joo Resources Berhad is a somewhat risky investment as a result of its debt. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Ann Joo Resources Berhad has 2 warning signs (and 1 which can't be ignored) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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