WMG Holdings Bhd (KLSE:WMG) Has A Somewhat Strained Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies WMG Holdings Bhd. (KLSE:WMG) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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

What Is WMG Holdings Bhd's Net Debt?

The image below, which you can click on for greater detail, shows that WMG Holdings Bhd had debt of RM234.3m at the end of June 2023, a reduction from RM244.4m over a year. On the flip side, it has RM37.3m in cash leading to net debt of about RM197.0m.

A Look At WMG Holdings Bhd's Liabilities

Zooming in on the latest balance sheet data, we can see that WMG Holdings Bhd had liabilities of RM179.8m due within 12 months and liabilities of RM99.1m due beyond that. Offsetting this, it had RM37.3m in cash and RM48.9m in receivables that were due within 12 months. So its liabilities total RM192.8m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the RM82.4m 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.

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). 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).

WMG Holdings Bhd shareholders face the double whammy of a high net debt to EBITDA ratio (11.8), and fairly weak interest coverage, since EBIT is just 0.97 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 RM12m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is WMG Holdings Bhd'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, 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. Happily for any shareholders, WMG Holdings Bhd actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

To be frank both WMG Holdings Bhd's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We're quite clear that we consider WMG Holdings Bhd to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example WMG Holdings Bhd has 2 warning signs (and 1 which is concerning) we think you should know about.

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.

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.