Here's Why Hume Cement Industries Berhad (KLSE:HUMEIND) Has A Meaningful Debt Burden

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Hume Cement Industries Berhad (KLSE:HUMEIND) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 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. 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 Hume Cement Industries Berhad

What Is Hume Cement Industries Berhad's Net Debt?

As you can see below, Hume Cement Industries Berhad had RM651.5m of debt at December 2020, down from RM686.7m a year prior. However, because it has a cash reserve of RM93.0m, its net debt is less, at about RM558.5m.

How Strong Is Hume Cement Industries Berhad's Balance Sheet?

According to the last reported balance sheet, Hume Cement Industries Berhad had liabilities of RM459.1m due within 12 months, and liabilities of RM440.6m due beyond 12 months. Offsetting these obligations, it had cash of RM93.0m as well as receivables valued at RM41.8m due within 12 months. So its liabilities total RM764.9m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of RM610.8m, we think shareholders really should watch Hume Cement Industries Berhad's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Hume Cement Industries Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (7.3), and fairly weak interest coverage, since EBIT is just 0.44 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for Hume Cement Industries Berhad is that it turned last year's EBIT loss into a gain of RM11m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hume Cement Industries 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 it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Hume Cement Industries 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

On the face of it, Hume Cement Industries Berhad's net debt to EBITDA left us tentative about the stock, and its interest cover was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Hume Cement Industries Berhad stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. Even though Hume Cement Industries Berhad lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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