Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Press Metal Aluminum Holdings Berhad (KLSE:PMETAL) is in debt. But the more important question is: what risk does this debt create?

Why is debt risky?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.

Check out our latest analysis for Press Metal Aluminum Holdings Berhad

How much debt does Press Metal Aluminum Holdings Berhad have?

The image below, which you can click on for more details, shows that as of March 2022, Press Metal Aluminum Holdings Berhad had debt of RM6.70 billion, up from RM5.37 billion in one year . On the other hand, he has RM268.4 million in cash, resulting in a net debt of around RM6.43 billion.

How strong is Press Metal Aluminum Holdings Berhad’s balance sheet?

Zooming in on the latest balance sheet data, we can see that Press Metal Aluminum Holdings Berhad had liabilities of RM5.79b due within 12 months and liabilities of RM5.40b due beyond. As compensation for these obligations, it had cash of RM268.4 million and receivables valued at RM2.88 billion due within 12 months. Thus, its liabilities total RM8.04 billion more than the combination of its cash and short-term receivables.

Given that publicly traded Press Metal Aluminum Holdings Berhad shares are worth a total of RM41.1 billion, it seems unlikely that this level of liability is a major threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.

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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Press Metal Aluminum Holdings Berhad’s net debt is 2.8 times its EBITDA, which is high but still reasonable leverage. But its EBIT was around 13.7 times its interest expense, implying that the company isn’t really paying a high cost to maintain that level of leverage. Even if the low cost turns out to be unsustainable, that’s a good sign. Importantly, Press Metal Aluminum Holdings Berhad has grown its EBIT by 89% over the last twelve months, and this growth will make it easier to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Press Metal Aluminum Holdings Berhad can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Press Metal Aluminum Holdings Berhad has had negative free cash flow, overall. Debt is generally more expensive and almost always riskier in the hands of a company with negative free cash flow. Shareholders should hope for an improvement.

Our point of view

Press Metal Aluminum Holdings Berhad’s interest coverage was a real benefit in this analysis, as was its EBIT growth rate. But truth be told, his conversion from EBIT to free cash flow had us biting our nails. Given this range of data points, we believe that Press Metal Aluminum Holdings Berhad is in a good position to manage its level of leverage. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. We have identified 3 warning signs with Press Metal Aluminum Holdings Berhad (at least 1, which is significant), and understanding them should be part of your investment process.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

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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.