Does LB Aluminum Berhad (KLSE: LBALUM) have a healthy balance sheet?
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies LB Aluminum Berhad (KLSE:LBALUM) uses debt. But should shareholders worry about its use of debt?
What risk does debt carry?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.
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What is LB Aluminum Berhad’s debt?
As you can see below, at the end of July 2022, LB Aluminum Berhad had a debt of RM289.1 million, compared to RM215.4 million a year ago. Click on the image for more details. On the other hand, he has RM37.2 million in cash, resulting in a net debt of around RM251.9 million.
How healthy is LB Aluminum Berhad’s balance sheet?
Zooming in on the latest balance sheet data, we can see that LB Aluminum Berhad had liabilities of RM429.3m due within 12 months and liabilities of RM65.9m due beyond. On the other hand, it had cash of RM37.2 million and RM154.3 million of receivables due within one year. It therefore has liabilities totaling RM303.7 million more than its cash and short-term receivables, combined.
This deficit casts a shadow over the RM184.8m company, like a towering colossus of mere mortals. So we definitely think shareholders need to watch this one closely. After all, LB Aluminum Berhad would likely need a major recapitalization if it were to pay its creditors today.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
LB Aluminum Berhad has a net debt to EBITDA ratio of 3.5, suggesting it uses good leverage to boost returns. But the high interest coverage of 8.7 suggests it can easily repay that debt. Importantly, LB Aluminum Berhad has grown its EBIT by 56% over the last twelve months, and this growth will make it easier to manage its debt. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since LB Aluminum Berhad will need revenue to repay this debt. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.
Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, LB Aluminum Berhad has burned a lot of money. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
To be frank, LB Aluminum Berhad’s EBIT to free cash flow conversion and its track record of keeping its total liabilities under control makes us rather uncomfortable with its level of leverage. But at least it’s decent enough to increase its EBIT; it’s encouraging. Looking at the big picture, it seems clear to us that LB Aluminum Berhad’s use of debt creates risks for the business. If all goes well, this should boost returns, but on the other hand, the risk of permanent capital loss is increased by debt. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. To do this, you need to find out about the 4 warning signs we spotted some with LB Aluminum Berhad (including 2 that are significant).
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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