These 4 Measures Indicate That Jaya Tiasa Holdings Berhad (KLSE:JTIASA) Is Using Debt Extensively

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. We can see that Jaya Tiasa Holdings Berhad (KLSE:JTIASA) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Jaya Tiasa Holdings Berhad

What Is Jaya Tiasa Holdings Berhad's Debt?

The image below, which you can click on for greater detail, shows that Jaya Tiasa Holdings Berhad had debt of RM785.6m at the end of June 2020, a reduction from RM934.6m over a year. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is Jaya Tiasa Holdings Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jaya Tiasa Holdings Berhad had liabilities of RM759.5m due within 12 months and liabilities of RM262.6m due beyond that. On the other hand, it had cash of RM13.3m and RM43.8m worth of receivables due within a year. So its liabilities total RM965.1m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's RM793.8m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While we wouldn't worry about Jaya Tiasa Holdings Berhad's net debt to EBITDA ratio of 4.0, we think its super-low interest cover of 0.41 times is a sign of high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. However, the silver lining was that Jaya Tiasa Holdings Berhad achieved a positive EBIT of RM21m in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Jaya Tiasa Holdings Berhad's ability to maintain a healthy balance sheet going forward. 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. Happily for any shareholders, Jaya Tiasa Holdings Berhad actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

We'd go so far as to say Jaya Tiasa Holdings Berhad's interest cover was disappointing. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Jaya Tiasa Holdings Berhad's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. Even though Jaya Tiasa Holdings Berhad lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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