Is IJM Corporation Berhad (KLSE:IJM) A Risky Investment?

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. We can see that IJM Corporation Berhad (KLSE:IJM) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for IJM Corporation Berhad

What Is IJM Corporation Berhad's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 IJM Corporation Berhad had debt of RM7.19b, up from RM6.83b in one year. However, it also had RM3.00b in cash, and so its net debt is RM4.19b.

How Healthy Is IJM Corporation Berhad's Balance Sheet?

According to the last reported balance sheet, IJM Corporation Berhad had liabilities of RM5.77b due within 12 months, and liabilities of RM6.20b due beyond 12 months. Offsetting this, it had RM3.00b in cash and RM2.28b in receivables that were due within 12 months. So its liabilities total RM6.68b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's RM6.03b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

IJM Corporation Berhad's net debt is 4.2 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 10.5 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Shareholders should be aware that IJM Corporation Berhad's EBIT was down 25% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine IJM Corporation Berhad's ability to maintain a healthy balance sheet going forward. 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 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. In the last three years, IJM Corporation Berhad's free cash flow amounted to 21% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say IJM Corporation Berhad's EBIT growth rate was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. We're quite clear that we consider IJM Corporation Berhad to be really rather risky, as a result of its balance sheet health. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that IJM Corporation Berhad is showing 2 warning signs in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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