Here's Why CME Group Berhad (KLSE:CME) Has A Meaningful Debt Burden

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that CME Group Berhad (KLSE:CME) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for CME Group Berhad

What Is CME Group Berhad's Debt?

The image below, which you can click on for greater detail, shows that CME Group Berhad had debt of RM32.2m at the end of September 2024, a reduction from RM36.6m over a year. However, it does have RM6.15m in cash offsetting this, leading to net debt of about RM26.1m.

A Look At CME Group Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that CME Group Berhad had liabilities of RM60.4m due within 12 months and liabilities of RM2.46m due beyond that. Offsetting these obligations, it had cash of RM6.15m as well as receivables valued at RM10.0m due within 12 months. So it has liabilities totalling RM46.7m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the RM12.1m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, CME Group Berhad would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

CME Group Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (18.2), and fairly weak interest coverage, since EBIT is just 1.00 times the interest expense. This means we'd consider it to have a heavy debt load. However, the silver lining was that CME Group Berhad achieved a positive EBIT of RM1.2m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But it is CME Group Berhad's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, CME Group Berhad actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, CME Group Berhad's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, it seems to us that CME Group Berhad'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. 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. We've identified 3 warning signs with CME Group Berhad (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

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.