Warren Buffett said: “Volatility is far from synonymous with risk”. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Above all, Timah Resources Limited (ASX: TML) carries debt. But the most important question is: what risk does this debt create?
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. 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. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
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What is the net debt of Timah Resources?
You can click on the graph below for historical figures, but it shows that Timah Resources had RM30.4million in debt in June 2021, up from RM49.7million a year earlier. On the other hand, he has RM6.81million in cash, resulting in net debt of about RM23.6million.
How strong is Timah Resources’ balance sheet?
According to the latest published balance sheet, Timah Resources had liabilities of RM 1.35 million due within 12 months and liabilities of RM 38.0 million due beyond 12 months. In compensation for these obligations, he had cash of RM 6.81 million as well as receivables valued at RM 2.66 million due within 12 months. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by RM29.8 million.
Since this deficit is actually greater than the company’s market cap of RM 23.7million, we believe shareholders should really watch Timah Resources’ debt levels, like a parent watching their child go crazy. cycling for the first time. Hypothetically, extremely high dilution would be required if the company were forced to repay its debts by raising capital at the current share price.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
While we are not worried about Timah Resources’ net debt to EBITDA ratio of 4.6, we do think its ultra-low 1.0 times interest coverage is a sign of high leverage. This is in large part due to the company’s large depreciation and amortization charges, which arguably means that its EBITDA is a very generous measure of profit, and its debt may be heavier than it appears. At first glance. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. Worse yet, Timah Resources’ EBIT was 40% lower than last year. If the income continues like this for the long term, there is an incredible chance to pay off that debt. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in isolation; since Timah Resources will need revenue to repay this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past two years, Timah Resources 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
At first glance, Timah Resources’ interest hedging left us hesitant about the stock, and its EBIT growth rate was no more attractive than the single empty restaurant on the busiest night of the year. . But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Overall, it seems to us that Timah Resources’ balance sheet is really very risky for the company. We are therefore almost as wary of this stock as a hungry kitten falls into its owner’s fish pond: once bitten, twice shy, as they say. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, Timah Resources has 4 warning signs (and 2 which don’t suit us very well) we think you should be aware of.
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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 shares 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 material. Simply Wall St has no position in the mentioned stocks.
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