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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 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. We note that Bumitama Agri Ltd. (SGX:P8Z) does have debt on its balance sheet. 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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Bumitama Agri
How Much Debt Does Bumitama Agri Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Bumitama Agri had Rp5.72t of debt, an increase on Rp4.99t, over one year. However, it does have Rp285.7b in cash offsetting this, leading to net debt of about Rp5.44t.
How Healthy Is Bumitama Agri's Balance Sheet?
The latest balance sheet data shows that Bumitama Agri had liabilities of Rp4.31t due within a year, and liabilities of Rp3.22t falling due after that. Offsetting this, it had Rp285.7b in cash and Rp367.5b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by Rp6.88t.
This deficit is considerable relative to its market capitalization of Rp11t, so it does suggest shareholders should keep an eye on Bumitama Agri's use of debt. So should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Because it carries more debt than cash, we think it's worth watching Bumitama Agri's balance sheet over time.
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.
Bumitama Agri's net debt is 2.63 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 37.1 times its interest expense, implying the company isn't really paying full freight on that debt. Even if not sustainable, that is a good sign. Importantly, Bumitama Agri's EBIT fell a jaw-dropping 20% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Bumitama Agri 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. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Bumitama Agri produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Neither Bumitama Agri's ability to grow its EBIT nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Taking the abovementioned factors together we do think Bumitama Agri's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Bumitama Agri's dividend history, without delay!
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Thank you for reading.