These 4 Measures Indicate That Bermaz Auto Berhad (KLSE:BAUTO) Is Using Debt Reasonably Well

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 note that Bermaz Auto Berhad (KLSE:BAUTO) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Bermaz Auto Berhad

What Is Bermaz Auto Berhad's Debt?

The image below, which you can click on for greater detail, shows that at October 2020 Bermaz Auto Berhad had debt of RM128.5m, up from RM45.0m in one year. However, its balance sheet shows it holds RM355.1m in cash, so it actually has RM226.6m net cash.

How Healthy Is Bermaz Auto Berhad's Balance Sheet?

We can see from the most recent balance sheet that Bermaz Auto Berhad had liabilities of RM428.6m falling due within a year, and liabilities of RM185.4m due beyond that. Offsetting these obligations, it had cash of RM355.1m as well as receivables valued at RM128.7m due within 12 months. So its liabilities total RM130.2m more than the combination of its cash and short-term receivables.

Given Bermaz Auto Berhad has a market capitalization of RM1.59b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. 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.

It is just as well that Bermaz Auto Berhad's load is not too heavy, because its EBIT was down 75% over the last year. 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 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. 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. Over the last three years, Bermaz Auto Berhad actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

We could understand if investors are concerned about Bermaz Auto Berhad's liabilities, but we can be reassured by the fact it has has net cash of RM226.6m. And it impressed us with free cash flow of RM114m, being 113% of its EBIT. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Bermaz Auto Berhad you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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. 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.
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