Is Gas Malaysia Berhad (KLSE:GASMSIA) Using Too Much Debt?

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. Importantly, Gas Malaysia Berhad (KLSE:GASMSIA) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Gas Malaysia Berhad

What Is Gas Malaysia Berhad's Net Debt?

As you can see below, at the end of September 2020, Gas Malaysia Berhad had RM455.0m of debt, up from RM281.0m a year ago. Click the image for more detail. However, because it has a cash reserve of RM400.3m, its net debt is less, at about RM54.7m.

How Strong Is Gas Malaysia Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gas Malaysia Berhad had liabilities of RM1.36b due within 12 months and liabilities of RM336.6m due beyond that. On the other hand, it had cash of RM400.3m and RM800.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM500.4m.

Given Gas Malaysia Berhad has a market capitalization of RM3.53b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Gas Malaysia Berhad's net debt is only 0.16 times its EBITDA. And its EBIT covers its interest expense a whopping 32.0 times over. So we're pretty relaxed about its super-conservative use of debt. The good news is that Gas Malaysia Berhad has increased its EBIT by 2.8% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Gas Malaysia Berhad's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Gas Malaysia Berhad's free cash flow amounted to 30% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Gas Malaysia Berhad's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. We would also note that Gas Utilities industry companies like Gas Malaysia Berhad commonly do use debt without problems. All these things considered, it appears that Gas Malaysia Berhad can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. For example, we've discovered 2 warning signs for Gas Malaysia Berhad that you should be aware of before investing here.

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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