Is WMG Holdings Bhd (KLSE:WMG) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that WMG Holdings Bhd. (KLSE:WMG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for WMG Holdings Bhd

How Much Debt Does WMG Holdings Bhd Carry?

The image below, which you can click on for greater detail, shows that at September 2020 WMG Holdings Bhd had debt of RM240.5m, up from RM204.3m in one year. On the flip side, it has RM12.3m in cash leading to net debt of about RM228.3m.

How Healthy Is WMG Holdings Bhd's Balance Sheet?

We can see from the most recent balance sheet that WMG Holdings Bhd had liabilities of RM164.8m falling due within a year, and liabilities of RM105.0m due beyond that. Offsetting this, it had RM12.3m in cash and RM42.6m in receivables that were due within 12 months. So its liabilities total RM214.9m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the RM106.1m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, WMG Holdings Bhd 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

WMG Holdings Bhd shareholders face the double whammy of a high net debt to EBITDA ratio (43.3), and fairly weak interest coverage, since EBIT is just 0.026 times the interest expense. The debt burden here is substantial. One redeeming factor for WMG Holdings Bhd is that it turned last year's EBIT loss into a gain of RM250k, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is WMG Holdings Bhd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, WMG Holdings Bhd 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

To be frank both WMG Holdings Bhd's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. We think the chances that WMG Holdings Bhd 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. 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 instance, we've identified 4 warning signs for WMG Holdings Bhd (2 are concerning) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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