Is Ibraco Berhad (KLSE:IBRACO) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Ibraco Berhad (KLSE:IBRACO) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ibraco Berhad

What Is Ibraco Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Ibraco Berhad had RM238.4m of debt in December 2020, down from RM259.1m, one year before. On the flip side, it has RM61.9m in cash leading to net debt of about RM176.5m.

How Strong Is Ibraco Berhad's Balance Sheet?

The latest balance sheet data shows that Ibraco Berhad had liabilities of RM249.7m due within a year, and liabilities of RM124.1m falling due after that. Offsetting this, it had RM61.9m in cash and RM137.8m in receivables that were due within 12 months. So it has liabilities totalling RM174.0m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of RM258.1m, so it does suggest shareholders should keep an eye on Ibraco Berhad's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Ibraco Berhad's debt is 2.8 times its EBITDA, and its EBIT cover its interest expense 6.0 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly Ibraco Berhad's EBIT was essentially flat over the last twelve months. We would prefer to see some earnings growth, because that always helps diminish 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 Ibraco Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Ibraco Berhad's free cash flow amounted to 23% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Both Ibraco Berhad's conversion of EBIT to free cash flow and its level of total liabilities were discouraging. At least its interest cover gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Ibraco Berhad is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Ibraco Berhad (of which 1 is a bit unpleasant!) you should know about.

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.

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