Does Press Metal Aluminium Holdings Berhad (KLSE:PMETAL) Have A Healthy 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.' 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 Press Metal Aluminium Holdings Berhad (KLSE:PMETAL) 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. 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. 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 Press Metal Aluminium Holdings Berhad

How Much Debt Does Press Metal Aluminium Holdings Berhad Carry?

The image below, which you can click on for greater detail, shows that at September 2021 Press Metal Aluminium Holdings Berhad had debt of RM5.55b, up from RM4.54b in one year. However, it also had RM393.3m in cash, and so its net debt is RM5.15b.

How Strong Is Press Metal Aluminium Holdings Berhad's Balance Sheet?

The latest balance sheet data shows that Press Metal Aluminium Holdings Berhad had liabilities of RM4.31b due within a year, and liabilities of RM4.57b falling due after that. Offsetting these obligations, it had cash of RM393.3m as well as receivables valued at RM1.76b due within 12 months. So it has liabilities totalling RM6.73b more than its cash and near-term receivables, combined.

Since publicly traded Press Metal Aluminium Holdings Berhad shares are worth a very impressive total of RM43.2b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Press Metal Aluminium Holdings Berhad has net debt to EBITDA of 2.9 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 9.7 suggests it can easily service that debt. Importantly, Press Metal Aluminium Holdings Berhad grew its EBIT by 75% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Press Metal Aluminium Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Press Metal Aluminium Holdings Berhad recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, Press Metal Aluminium Holdings Berhad's impressive EBIT growth rate implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. Looking at all the aforementioned factors together, it strikes us that Press Metal Aluminium Holdings Berhad can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Press Metal Aluminium Holdings Berhad , and understanding them should be part of your investment process.

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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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.