Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, United Overseas Australia Limited (ASX:UOS) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does United Overseas Australia Carry?
As you can see below, United Overseas Australia had AU$124.3m of debt at June 2020, down from AU$132.4m a year prior. However, it does have AU$447.8m in cash offsetting this, leading to net cash of AU$323.5m.
A Look At United Overseas Australia's Liabilities
Zooming in on the latest balance sheet data, we can see that United Overseas Australia had liabilities of AU$354.1m due within 12 months and liabilities of AU$59.6m due beyond that. On the other hand, it had cash of AU$447.8m and AU$245.6m worth of receivables due within a year. So it can boast AU$279.7m more liquid assets than total liabilities.
This excess liquidity suggests that United Overseas Australia is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, United Overseas Australia boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that United Overseas Australia has seen its EBIT plunge 18% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is United Overseas Australia's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While United Overseas Australia has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, United Overseas Australia recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company's debt, in this case United Overseas Australia has AU$323.5m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of AU$193m, being 86% of its EBIT. So is United Overseas Australia's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that United Overseas Australia is showing 1 warning sign in our investment analysis , you should know about...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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This article by Simply Wall St is general in nature. 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.
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