Is Mudajaya Group Berhad (KLSE:MUDAJYA) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Mudajaya Group Berhad (KLSE:MUDAJYA) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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?

The chart below, which you can click on for greater detail, shows that Mudajaya Group Berhad had RM844.9m in debt in December 2020; about the same as the year before. On the flip side, it has RM311.2m in cash leading to net debt of about RM533.7m.

How Healthy Is Mudajaya Group Berhad's Balance Sheet?

We can see from the most recent balance sheet that Mudajaya Group Berhad had liabilities of RM578.8m falling due within a year, and liabilities of RM502.8m due beyond that. On the other hand, it had cash of RM311.2m and RM190.7m worth of receivables due within a year. So its liabilities total RM579.7m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the RM162.2m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Mudajaya Group Berhad would likely require a major re-capitalisation if it had to pay its creditors today.

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). 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).

Mudajaya Group Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (8.3), and fairly weak interest coverage, since EBIT is just 0.92 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Mudajaya Group Berhad saw its EBIT tank 86% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Mudajaya Group Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Mudajaya Group Berhad saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Mudajaya Group Berhad's EBIT growth rate 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. And furthermore, its interest cover also fails to instill confidence. It looks to us like Mudajaya Group Berhad carries a significant balance sheet burden. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Mudajaya Group Berhad you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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