Does LB Aluminium Berhad (KLSE:LBALUM) Have A Healthy Balance Sheet?

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.' 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. As with many other companies LB Aluminium Berhad (KLSE:LBALUM) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for LB Aluminium Berhad

How Much Debt Does LB Aluminium Berhad Carry?

As you can see below, at the end of July 2022, LB Aluminium Berhad had RM289.1m of debt, up from RM215.4m a year ago. Click the image for more detail. On the flip side, it has RM37.2m in cash leading to net debt of about RM251.9m.

How Healthy Is LB Aluminium Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that LB Aluminium Berhad had liabilities of RM429.3m due within 12 months and liabilities of RM65.9m due beyond that. On the other hand, it had cash of RM37.2m and RM154.3m worth of receivables due within a year. So it has liabilities totalling RM303.7m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the RM184.8m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, LB Aluminium Berhad would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

LB Aluminium Berhad has net debt to EBITDA of 3.5 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 8.7 suggests it can easily service that debt. Importantly, LB Aluminium Berhad grew its EBIT by 56% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since LB Aluminium Berhad will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, LB Aluminium Berhad burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both LB Aluminium Berhad's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. Looking at the bigger picture, it seems clear to us that LB Aluminium Berhad's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. To that end, you should learn about the 4 warning signs we've spotted with LB Aluminium Berhad (including 2 which are significant) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.