Is Ann Joo Resources Berhad (KLSE:ANNJOO) A Risky Investment?

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 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 Ann Joo Resources Berhad (KLSE:ANNJOO) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Ann Joo Resources Berhad

What Is Ann Joo Resources Berhad's Debt?

As you can see below, Ann Joo Resources Berhad had RM995.0m of debt, at September 2021, which is about the same as the year before. You can click the chart for greater detail. However, it does have RM95.7m in cash offsetting this, leading to net debt of about RM899.4m.

A Look At Ann Joo Resources Berhad's Liabilities

According to the last reported balance sheet, Ann Joo Resources Berhad had liabilities of RM1.20b due within 12 months, and liabilities of RM67.7m due beyond 12 months. Offsetting this, it had RM95.7m in cash and RM433.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM736.9m.

This is a mountain of leverage relative to its market capitalization of RM1.01b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Ann Joo Resources Berhad's net debt to EBITDA ratio of about 2.4 suggests only moderate use of debt. And its strong interest cover of 12.9 times, makes us even more comfortable. Notably, Ann Joo Resources Berhad made a loss at the EBIT level, last year, but improved that to positive EBIT of RM309m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. Looking at the most recent year, Ann Joo Resources Berhad recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Neither Ann Joo Resources Berhad's ability to handle its total liabilities nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But its interest cover 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. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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 instance, we've identified 4 warning signs for Ann Joo Resources Berhad (2 make us uncomfortable) you should be aware of.

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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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.