Is Press Metal Aluminium Holdings Berhad (KLSE:PMETAL) Using Too Much Debt?

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

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for Press Metal Aluminium Holdings Berhad

What Is Press Metal Aluminium Holdings Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that Press Metal Aluminium Holdings Berhad had RM4.36b of debt in June 2023, down from RM5.67b, one year before. However, because it has a cash reserve of RM772.5m, its net debt is less, at about RM3.59b.

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

We can see from the most recent balance sheet that Press Metal Aluminium Holdings Berhad had liabilities of RM2.51b falling due within a year, and liabilities of RM4.26b due beyond that. Offsetting these obligations, it had cash of RM772.5m as well as receivables valued at RM1.30b due within 12 months. So it has liabilities totalling RM4.70b more than its cash and near-term receivables, combined.

Since publicly traded Press Metal Aluminium Holdings Berhad shares are worth a total of RM38.7b, 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Press Metal Aluminium Holdings Berhad's net debt of 1.6 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 8.4 times its interest expenses harmonizes with that theme. But the bad news is that Press Metal Aluminium Holdings Berhad has seen its EBIT plunge 15% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Press Metal Aluminium 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Press Metal Aluminium Holdings Berhad's free cash flow amounted to 44% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Press Metal Aluminium Holdings Berhad's struggle to grow its EBIT had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its interest cover is relatively strong. We think that Press Metal Aluminium Holdings Berhad's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Press Metal Aluminium Holdings Berhad .

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.