Howard Marks put 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 every investor practice that I know is worried. When we think about how risky a business is, we always like to look at its use of debt, because overloading debt can lead to bankruptcy. We notice that TAS Offshore Berhad (KLSE: TAS) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution of a business with the ability to reinvest at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest review for TAS Offshore Berhad
What is the debt of TAS Offshore Berhad?
You can click on the graph below for the historical figures, but it shows that TAS Offshore Berhad had a debt of RM 10.4million in August 2021, up from RM16.9million a year earlier. On the other hand, he has RM7.23million in cash, resulting in net debt of about RM3.20million.
How healthy is TAS Offshore Berhad’s balance sheet?
According to the latest published balance sheet, TAS Offshore Berhad had liabilities of RM 21.9 million due within 12 months and liabilities of RM 9.03 million due beyond 12 months. On the other hand, he had a cash position of RM7.23 million and RM10.0 million of receivables due within one year. Thus, its liabilities total RM13.7 million more than the combination of its cash and short-term receivables.
This deficit is not that big as TAS Offshore Berhad is worth 43.7 million RM, and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
TAS Offshore Berhad has a low net debt to EBITDA ratio of just 0.29. And its EBIT covers its interest costs a whopping 18.5 times. So we’re pretty relaxed about its ultra-conservative use of debt. Although TAS Offshore Berhad recorded a loss in EBIT level last year it was also good to see that it generated RM 9.8 million EBIT in the last twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in isolation; since TAS Offshore Berhad will need income to repay this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. It is therefore worth checking to what extent profit before interest and taxes (EBIT) is supported by free cash flow. Over the past year, TAS Offshore Berhad has actually generated more free cash flow than EBIT. There is nothing better than cash flow to stay in the good graces of your lenders.
Our point of view
Fortunately, TAS Offshore Berhad’s impressive interest coverage means that it has the upper hand over its debt. And the good news does not end there, since its conversion of EBIT into free cash flow also confirms this impression! When we consider the range of factors above, it looks like TAS Offshore Berhad is being pretty reasonable with its use of debt. While this carries some risk, it can also improve returns for shareholders. When analyzing debt levels, the balance sheet is the obvious place to start. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 2 warning signs for TAS Offshore Berhad that you need to be aware of.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash-flow net-growth stocks.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.