LB Aluminium Berhad (KLSE:LBALUM) Has A Somewhat Strained Balance Sheet

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, LB Aluminium Berhad (KLSE:LBALUM) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for LB Aluminium Berhad

How Much Debt Does LB Aluminium Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that as of January 2022 LB Aluminium Berhad had RM256.3m of debt, an increase on RM176.0m, over one year. However, because it has a cash reserve of RM52.3m, its net debt is less, at about RM204.0m.

How Strong 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 RM391.6m due within 12 months and liabilities of RM64.4m due beyond that. Offsetting this, it had RM52.3m in cash and RM126.8m in receivables that were due within 12 months. So it has liabilities totalling RM276.8m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the RM169.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, LB Aluminium Berhad would probably need a major re-capitalization if its creditors were to demand repayment.

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.

With net debt to EBITDA of 3.5 LB Aluminium Berhad has a fairly noticeable amount of debt. But the high interest coverage of 7.4 suggests it can easily service that debt. Pleasingly, LB Aluminium Berhad is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 163% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is LB Aluminium 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, LB Aluminium Berhad saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is 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. Overall, it seems to us that LB Aluminium Berhad's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for LB Aluminium Berhad (of which 1 makes us a bit uncomfortable!) you should know about.

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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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.