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.' 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 WCT Holdings Berhad (KLSE:WCT) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does WCT Holdings Berhad Carry?
You can click the graphic below for the historical numbers, but it shows that WCT Holdings Berhad had RM2.96b of debt in December 2020, down from RM3.09b, one year before. However, because it has a cash reserve of RM526.7m, its net debt is less, at about RM2.43b.
How Healthy Is WCT Holdings Berhad's Balance Sheet?
We can see from the most recent balance sheet that WCT Holdings Berhad had liabilities of RM2.39b falling due within a year, and liabilities of RM2.53b due beyond that. On the other hand, it had cash of RM526.7m and RM1.87b worth of receivables due within a year. So it has liabilities totalling RM2.52b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the RM743.7m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, WCT Holdings Berhad would likely require a major re-capitalisation if it had to pay its creditors today.
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.
WCT Holdings Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (46.2), and fairly weak interest coverage, since EBIT is just 0.22 times the interest expense. The debt burden here is substantial. Worse, WCT Holdings Berhad's EBIT was down 82% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine WCT Holdings 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, WCT Holdings Berhad's free cash flow amounted to 43% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
On the face of it, WCT Holdings 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. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. We think the chances that WCT Holdings Berhad has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - WCT Holdings Berhad has 1 warning sign we think you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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