Here's Why Only World Group Holdings Berhad (KLSE:OWG) Can Manage Its Debt Responsibly

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. Importantly, Only World Group Holdings Berhad (KLSE:OWG) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Only World Group Holdings Berhad

What Is Only World Group Holdings Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that Only World Group Holdings Berhad had debt of RM71.7m at the end of December 2022, a reduction from RM78.8m over a year. On the flip side, it has RM41.3m in cash leading to net debt of about RM30.4m.

How Strong Is Only World Group Holdings Berhad's Balance Sheet?

The latest balance sheet data shows that Only World Group Holdings Berhad had liabilities of RM47.6m due within a year, and liabilities of RM125.2m falling due after that. Offsetting this, it had RM41.3m in cash and RM11.6m in receivables that were due within 12 months. So its liabilities total RM119.8m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Only World Group Holdings Berhad is worth RM211.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Given net debt is only 0.96 times EBITDA, it is initially surprising to see that Only World Group Holdings Berhad's EBIT has low interest coverage of 1.0 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Notably, Only World Group Holdings Berhad made a loss at the EBIT level, last year, but improved that to positive EBIT of RM12m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Only World Group Holdings Berhad'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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, Only World Group Holdings Berhad actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Based on what we've seen Only World Group Holdings Berhad is not finding it easy, given its interest cover, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Only World Group Holdings Berhad's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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 3 warning signs for Only World Group Holdings Berhad (1 is a bit unpleasant!) that you should be aware of before investing here.

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. 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.