Stock Analysis

Does 7-Eleven Malaysia Holdings Berhad (KLSE:SEM) Have A Healthy Balance Sheet?

KLSE:SEM
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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. We can see that 7-Eleven Malaysia Holdings Berhad (KLSE:SEM) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out the opportunities and risks within the XX Consumer Retailing industry.

How Much Debt Does 7-Eleven Malaysia Holdings Berhad Carry?

As you can see below, 7-Eleven Malaysia Holdings Berhad had RM745.3m of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has RM242.2m in cash leading to net debt of about RM503.2m.

debt-equity-history-analysis
KLSE:SEM Debt to Equity History October 19th 2022

How Strong Is 7-Eleven Malaysia Holdings Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that 7-Eleven Malaysia Holdings Berhad had liabilities of RM954.4m due within 12 months and liabilities of RM1.33b due beyond that. On the other hand, it had cash of RM242.2m and RM89.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM1.95b.

This is a mountain of leverage relative to its market capitalization of RM2.00b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

7-Eleven Malaysia Holdings Berhad's net debt is sitting at a very reasonable 1.8 times its EBITDA, while its EBIT covered its interest expense just 3.4 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. It is well worth noting that 7-Eleven Malaysia Holdings Berhad's EBIT shot up like bamboo after rain, gaining 64% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if 7-Eleven Malaysia Holdings Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, 7-Eleven Malaysia Holdings Berhad actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Both 7-Eleven Malaysia Holdings Berhad's ability to to convert EBIT to free cash flow and its EBIT growth rate gave us comfort that it can handle its debt. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that 7-Eleven Malaysia Holdings Berhad is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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 example, we've discovered 1 warning sign for 7-Eleven Malaysia Holdings Berhad that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

Valuation is complex, but we're helping make it simple.

Find out whether 7-Eleven Malaysia Holdings Berhad is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.