We Think UMW Holdings Berhad (KLSE:UMW) Can Manage Its Debt With Ease

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that UMW Holdings Berhad (KLSE:UMW) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for UMW Holdings Berhad

What Is UMW Holdings Berhad's Debt?

The image below, which you can click on for greater detail, shows that UMW Holdings Berhad had debt of RM1.55b at the end of December 2022, a reduction from RM2.73b over a year. But it also has RM3.00b in cash to offset that, meaning it has RM1.45b net cash.

How Strong Is UMW Holdings Berhad's Balance Sheet?

We can see from the most recent balance sheet that UMW Holdings Berhad had liabilities of RM3.60b falling due within a year, and liabilities of RM1.68b due beyond that. Offsetting these obligations, it had cash of RM3.00b as well as receivables valued at RM1.25b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM1.02b.

While this might seem like a lot, it is not so bad since UMW Holdings Berhad has a market capitalization of RM4.30b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, UMW Holdings Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that UMW Holdings Berhad grew its EBIT by 162% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if UMW Holdings Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. UMW Holdings Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, UMW Holdings Berhad actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While UMW Holdings Berhad does have more liabilities than liquid assets, it also has net cash of RM1.45b. The cherry on top was that in converted 118% of that EBIT to free cash flow, bringing in RM694m. So we don't think UMW Holdings Berhad's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with UMW Holdings Berhad .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.