Is Muda Holdings Berhad (KLSE:MUDA) Using Too Much Debt?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Muda Holdings Berhad (KLSE:MUDA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Muda Holdings Berhad

What Is Muda Holdings Berhad's Debt?

As you can see below, Muda Holdings Berhad had RM736.2m of debt, at June 2023, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has RM125.8m in cash leading to net debt of about RM610.4m.

How Healthy Is Muda Holdings Berhad's Balance Sheet?

According to the last reported balance sheet, Muda Holdings Berhad had liabilities of RM750.0m due within 12 months, and liabilities of RM324.3m due beyond 12 months. On the other hand, it had cash of RM125.8m and RM304.1m worth of receivables due within a year. So its liabilities total RM644.5m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of RM500.3m, we think shareholders really should watch Muda Holdings 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Muda 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.

In the last year Muda Holdings Berhad had a loss before interest and tax, and actually shrunk its revenue by 13%, to RM1.6b. That's not what we would hope to see.

Caveat Emptor

While Muda Holdings Berhad's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at RM43m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of RM45m. And until that time we think this is a risky stock. 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 - Muda Holdings Berhad has 3 warning signs we think you should be aware of.

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.