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

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Mudajaya Group Berhad (KLSE:MUDAJYA) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. 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

What Is Mudajaya Group Berhad's Debt?

The image below, which you can click on for greater detail, shows that Mudajaya Group Berhad had debt of RM461.8m at the end of March 2022, a reduction from RM839.0m over a year. However, because it has a cash reserve of RM124.6m, its net debt is less, at about RM337.3m.

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 RM315.7m falling due within a year, and liabilities of RM347.8m due beyond that. Offsetting these obligations, it had cash of RM124.6m as well as receivables valued at RM129.5m due within 12 months. So its liabilities total RM409.5m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the RM266.0m 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.

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).

Weak interest cover of 0.61 times and a disturbingly high net debt to EBITDA ratio of 7.3 hit our confidence in Mudajaya Group Berhad like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. One redeeming factor for Mudajaya Group Berhad is that it turned last year's EBIT loss into a gain of RM23m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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, Mudajaya Group Berhad actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, Mudajaya Group Berhad's net debt to EBITDA left us tentative about the stock, and its interest cover was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, we think it's fair to say that Mudajaya Group Berhad has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. For example Mudajaya Group Berhad has 4 warning signs (and 2 which shouldn't be ignored) we think 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. 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.