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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies WMG Holdings Bhd. (KLSE:WMG) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that WMG is potentially undervalued!

What Is WMG Holdings Bhd's Debt?

As you can see below, WMG Holdings Bhd had RM244.4m of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of RM21.5m, its net debt is less, at about RM222.9m.

How Strong Is WMG Holdings Bhd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that WMG Holdings Bhd had liabilities of RM173.9m due within 12 months and liabilities of RM96.1m due beyond that. Offsetting these obligations, it had cash of RM21.5m as well as receivables valued at RM30.9m due within 12 months. So its liabilities total RM217.5m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the RM78.0m 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. 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 WMG Holdings Bhd 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.

In the last year WMG Holdings Bhd had a loss before interest and tax, and actually shrunk its revenue by 29%, to RM50m. To be frank that doesn't bode well.

Caveat Emptor

Not only did WMG Holdings Bhd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost RM456k at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it lost RM20m in just last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is quite risky. We'd prefer to pass. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for WMG Holdings Bhd (of which 1 is concerning!) you should know about.

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.