Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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. Importantly, Bermaz Auto Berhad (KLSE:BAUTO) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Bermaz Auto Berhad’s Net Debt?
The image below, which you can click on for greater detail, shows that at October 2019 Bermaz Auto Berhad had debt of RM45.0m, up from RM11.1m in one year. But it also has RM223.0m in cash to offset that, meaning it has RM178.0m net cash.
A Look At Bermaz Auto Berhad’s Liabilities
We can see from the most recent balance sheet that Bermaz Auto Berhad had liabilities of RM417.4m falling due within a year, and liabilities of RM205.4m due beyond that. On the other hand, it had cash of RM223.0m and RM190.4m worth of receivables due within a year. So it has liabilities totalling RM209.4m more than its cash and near-term receivables, combined.
Since publicly traded Bermaz Auto Berhad shares are worth a total of RM2.08b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Bermaz Auto Berhad also has more cash than debt, so we’re pretty confident it can manage its debt safely.
On the other hand, Bermaz Auto Berhad saw its EBIT drop by 6.0% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Bermaz Auto 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. While Bermaz Auto Berhad has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Bermaz Auto Berhad generated free cash flow amounting to a very robust 96% of its EBIT, more than we’d expect. That positions it well to pay down debt if desirable to do so.
Although Bermaz Auto Berhad’s balance sheet isn’t particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of RM178.0m. And it impressed us with free cash flow of RM21m, being 96% of its EBIT. So is Bermaz Auto Berhad’s debt a risk? It doesn’t seem so to us. 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. Like risks, for instance. Every company has them, and we’ve spotted 2 warning signs for Bermaz Auto Berhad (of which 1 can’t be ignored!) you should know about.
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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