David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Aemulus Holdings Berhad (KLSE:AEMULUS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
How Much Debt Does Aemulus Holdings Berhad Carry?
As you can see below, at the end of June 2021, Aemulus Holdings Berhad had RM26.7m of debt, up from RM21.9m a year ago. Click the image for more detail. However, it does have RM25.7m in cash offsetting this, leading to net debt of about RM1.00m.
How Strong Is Aemulus Holdings Berhad's Balance Sheet?
The latest balance sheet data shows that Aemulus Holdings Berhad had liabilities of RM23.5m due within a year, and liabilities of RM17.8m falling due after that. Offsetting this, it had RM25.7m in cash and RM35.5m in receivables that were due within 12 months. So it can boast RM19.9m more liquid assets than total liabilities.
This surplus suggests that Aemulus Holdings Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Carrying virtually no net debt, Aemulus Holdings Berhad has a very light debt load indeed.
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.
Looking at its net debt to EBITDA of 0.13 and interest cover of 6.3 times, it seems to us that Aemulus Holdings Berhad is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. It was also good to see that despite losing money on the EBIT line last year, Aemulus Holdings Berhad turned things around in the last 12 months, delivering and EBIT of RM5.1m. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Aemulus Holdings Berhad's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Aemulus Holdings Berhad saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Aemulus Holdings Berhad's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its net debt to EBITDA. When we consider all the factors mentioned above, we do feel a bit cautious about Aemulus Holdings Berhad's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Be aware that Aemulus Holdings Berhad is showing 2 warning signs in our investment analysis , and 1 of those is significant...
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.
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.
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