Does Bermaz Auto Berhad (KLSE:BAUTO) 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Bermaz Auto Berhad (KLSE:BAUTO) makes use of debt. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Bermaz Auto Berhad

What Is Bermaz Auto Berhad's Net Debt?

As you can see below, at the end of October 2024, Bermaz Auto Berhad had RM274.1m of debt, up from RM108.4m a year ago. Click the image for more detail. However, its balance sheet shows it holds RM458.3m in cash, so it actually has RM184.2m net cash.

How Strong Is Bermaz Auto Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Bermaz Auto Berhad had liabilities of RM619.3m due within 12 months and liabilities of RM384.6m due beyond that. Offsetting these obligations, it had cash of RM458.3m as well as receivables valued at RM193.0m due within 12 months. So its liabilities total RM352.5m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Bermaz Auto Berhad has a market capitalization of RM1.22b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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.

In fact Bermaz Auto Berhad's saving grace is its low debt levels, because its EBIT has tanked 39% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Bermaz Auto Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Bermaz Auto Berhad produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Bermaz Auto Berhad does have more liabilities than liquid assets, it also has net cash of RM184.2m. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in RM110m. So we are not troubled with Bermaz Auto Berhad's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Bermaz Auto Berhad (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

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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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.