Does Mudajaya Group Berhad (KLSE:MUDAJYA) Have A Healthy Balance Sheet?

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. Importantly, Mudajaya Group Berhad (KLSE:MUDAJYA) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Mudajaya Group Berhad

How Much Debt Does Mudajaya Group Berhad Carry?

As you can see below, Mudajaya Group Berhad had RM472.0m of debt at September 2022, down from RM840.1m a year prior. On the flip side, it has RM123.2m in cash leading to net debt of about RM348.8m.

How Healthy Is Mudajaya Group Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Mudajaya Group Berhad had liabilities of RM423.7m due within 12 months and liabilities of RM258.9m due beyond that. Offsetting these obligations, it had cash of RM123.2m as well as receivables valued at RM159.3m due within 12 months. So its liabilities total RM400.1m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of RM478.3m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.86 times and a disturbingly high net debt to EBITDA ratio of 7.5 hit our confidence in Mudajaya Group Berhad like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Mudajaya Group Berhad is that it turned last year's EBIT loss into a gain of RM24m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Mudajaya Group Berhad will need earnings to service that debt. 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. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Mudajaya 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

Neither Mudajaya Group Berhad's ability to cover its interest expense with its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Taking the abovementioned factors together we do think Mudajaya Group Berhad's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Mudajaya Group Berhad (1 is a bit concerning!) that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.