Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. 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. Like many other companies Astral Asia Berhad (KLSE:AASIA) uses debt. But does this debt worry shareholders?

Why is debt risky?

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 common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, many companies use debt to finance their growth, without any negative consequences. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

Check out our latest analysis for Astral Asia Berhad

What is Astral Asia Berhad’s net debt?

As you can see below, Astral Asia Berhad had a debt of RM10.3 million in September 2021, compared to RM14.6 million the previous year. However, he also had RM6.79 million in cash, so his net debt is RM3.50 million.

A look at the responsibilities of Astral Asia Berhad

We can see from the most recent balance sheet that Astral Asia Berhad had liabilities of RM7.68m due within one year, and liabilities of RM87.7m due beyond. On the other hand, it had cash of RM6.79 million and RM1.82 million of receivables due within the year. It therefore has liabilities totaling RM86.8 million more than its cash and short-term receivables, combined.

Given that this deficit is actually greater than the company’s market capitalization of RM72.6 million, we think shareholders should really be watching Astral Asia Berhad’s debt levels, like a parent watching their child. riding a bike for the first time. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.

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.

Given its net debt to EBITDA ratio of 0.53 and interest coverage of 6.1x, it seems to us that Astral Asia Berhad is probably using debt quite sensibly. But the interest payments are certainly enough to make us think about the affordability of its debt. Although Astral Asia Berhad recorded a loss in EBIT last year, it was also good to see that it generated RM3.8 million of EBIT in the last twelve months. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since Astral Asia 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 earnings before interest and tax (EBIT) is supported by free cash flow. Over the past year, Astral Asia Berhad has experienced substantial negative free cash flow, overall. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.

Our point of view

Reflecting on Astral Asia Berhad’s attempt to convert EBIT to free cash flow, we are certainly not enthusiastic. But on the bright side, its net debt to EBITDA is a good sign and makes us more optimistic. Overall, we think it’s fair to say that Astral Asia Berhad has enough debt that there are real risks around the balance sheet. If all goes well, it can pay off, but the downside of this debt is a greater risk of permanent losses. 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 this end, you should be aware of the 3 warning signs we spotted with Astral Asia Berhad.

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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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.