7-Eleven Malaysia Holdings Berhad (KLSE:SEM) Takes On Some Risk With Its Use Of 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.' 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 7-Eleven Malaysia Holdings Berhad (KLSE:SEM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for 7-Eleven Malaysia Holdings Berhad

What Is 7-Eleven Malaysia Holdings Berhad's Net Debt?

As you can see below, at the end of December 2020, 7-Eleven Malaysia Holdings Berhad had RM535.5m of debt, up from RM149.4m a year ago. Click the image for more detail. However, it does have RM206.3m in cash offsetting this, leading to net debt of about RM329.2m.

A Look At 7-Eleven Malaysia Holdings Berhad's Liabilities

We can see from the most recent balance sheet that 7-Eleven Malaysia Holdings Berhad had liabilities of RM902.7m falling due within a year, and liabilities of RM972.9m due beyond that. Offsetting these obligations, it had cash of RM206.3m as well as receivables valued at RM52.8m due within 12 months. So its liabilities total RM1.62b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of RM1.66b, so it does suggest shareholders should keep an eye on 7-Eleven Malaysia Holdings Berhad's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Even though 7-Eleven Malaysia Holdings Berhad's debt is only 1.7, its interest cover is really very low at 2.3. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. We saw 7-Eleven Malaysia Holdings Berhad grow its EBIT by 4.2% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine 7-Eleven Malaysia 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, 7-Eleven Malaysia Holdings Berhad actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

7-Eleven Malaysia Holdings Berhad's interest cover and level of total liabilities definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. We think that 7-Eleven Malaysia Holdings Berhad's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for 7-Eleven Malaysia Holdings Berhad (1 can't be ignored) you should be aware of.

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.

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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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