Is Asian Pac Holdings Berhad (KLSE:ASIAPAC) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Asian Pac Holdings Berhad (KLSE:ASIAPAC) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Asian Pac Holdings Berhad

How Much Debt Does Asian Pac Holdings Berhad Carry?

As you can see below, at the end of September 2020, Asian Pac Holdings Berhad had RM468.8m of debt, up from RM356.4m a year ago. Click the image for more detail. On the flip side, it has RM56.9m in cash leading to net debt of about RM411.9m.

A Look At Asian Pac Holdings Berhad's Liabilities

According to the last reported balance sheet, Asian Pac Holdings Berhad had liabilities of RM155.2m due within 12 months, and liabilities of RM791.4m due beyond 12 months. Offsetting this, it had RM56.9m in cash and RM91.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM798.0m.

This deficit casts a shadow over the RM140.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Asian Pac Holdings Berhad would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Asian Pac Holdings Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (7.8), and fairly weak interest coverage, since EBIT is just 2.1 times the interest expense. The debt burden here is substantial. Worse, Asian Pac Holdings Berhad's EBIT was down 20% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Asian Pac Holdings Berhad will need earnings to service that debt. 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 always check how much of that EBIT is translated into free cash flow. In the last three years, Asian Pac Holdings Berhad's free cash flow amounted to 25% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, Asian Pac Holdings Berhad's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its interest cover also fails to instill confidence. We think the chances that Asian Pac Holdings Berhad has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 5 warning signs for Asian Pac Holdings Berhad (2 shouldn't be ignored) you should be aware of.

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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