Auditors Are Concerned About United Malt Group (ASX:UMG)

The harsh reality for United Malt Group Limited (ASX:UMG) shareholders is that its auditors, PricewaterhouseCoopers LLP, expressed doubts about its ability to continue as a going concern, in its reported results to September 2022. Thus we can say that, based on the results to that date, the company should raise capital or otherwise raise cash, without much delay.

If the company does have to issue more shares, potential investors will be sure to consider how desperate it is for capital. So it is suddenly extremely important to consider whether the company is taking too much risk on its balance sheet. The biggest concern we would have is the company's debt, since its lenders might force the company into administration if it cannot repay them.

Our analysis indicates that UMG is potentially undervalued!

How Much Debt Does United Malt Group Carry?

As you can see below, at the end of September 2022, United Malt Group had AU$587.3m of debt, up from AU$518.7m a year ago. Click the image for more detail. However, it does have AU$224.7m in cash offsetting this, leading to net debt of about AU$362.6m.

How Strong Is United Malt Group's Balance Sheet?

We can see from the most recent balance sheet that United Malt Group had liabilities of AU$565.2m falling due within a year, and liabilities of AU$578.5m due beyond that. Offsetting these obligations, it had cash of AU$224.7m as well as receivables valued at AU$242.9m due within 12 months. So its liabilities total AU$676.1m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of AU$915.5m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

United Malt Group shareholders face the double whammy of a high net debt to EBITDA ratio (5.2), and fairly weak interest coverage, since EBIT is just 2.1 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, United Malt Group saw its EBIT tank 42% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine United Malt Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, United Malt Group recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both United Malt Group's net debt to EBITDA and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And even its level of total liabilities fails to inspire much confidence. Overall, it seems to us that United Malt Group's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. While some investors may specialize in these sort of situations, it's simply too risky and complicated for us to want to invest in a company after an auditor has expressed doubts about its ability to continue as a going concern. We prefer to invest in companies that ensure the balance sheet remains healthier than that. Given the risks around United Malt Group's use of debt, the sensible thing to do is to check if insiders have been unloading the stock.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.