Does UEM Edgenta Berhad (KLSE:EDGENTA) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies UEM Edgenta Berhad (KLSE:EDGENTA) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for UEM Edgenta Berhad

What Is UEM Edgenta Berhad's Debt?

As you can see below, UEM Edgenta Berhad had RM489.1m of debt at September 2020, down from RM533.3m a year prior. On the flip side, it has RM484.1m in cash leading to net debt of about RM5.01m.

A Look At UEM Edgenta Berhad's Liabilities

According to the last reported balance sheet, UEM Edgenta Berhad had liabilities of RM822.5m due within 12 months, and liabilities of RM442.1m due beyond 12 months. Offsetting this, it had RM484.1m in cash and RM922.0m in receivables that were due within 12 months. So it can boast RM141.5m more liquid assets than total liabilities.

This short term liquidity is a sign that UEM Edgenta Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Carrying virtually no net debt, UEM Edgenta Berhad has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

UEM Edgenta Berhad has very modest net debt levels, with net debt at just 0.036 times EBITDA. Happily, it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like an Olympic ice-skater handles a pirouette. In fact UEM Edgenta Berhad's saving grace is its low debt levels, because its EBIT has tanked 61% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if UEM Edgenta Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, UEM Edgenta Berhad generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, UEM Edgenta Berhad's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its EBIT growth rate has the opposite effect. Taking all this data into account, it seems to us that UEM Edgenta Berhad takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for UEM Edgenta Berhad you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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