GuocoLand (Malaysia) Berhad (KLSE:GUOCO) Takes On Some Risk With Its Use Of Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 GuocoLand (Malaysia) Berhad (KLSE:GUOCO) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is GuocoLand (Malaysia) Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that GuocoLand (Malaysia) Berhad had debt of RM459.8m at the end of December 2024, a reduction from RM508.7m over a year. However, it does have RM127.2m in cash offsetting this, leading to net debt of about RM332.6m.

A Look At GuocoLand (Malaysia) Berhad's Liabilities

The latest balance sheet data shows that GuocoLand (Malaysia) Berhad had liabilities of RM399.4m due within a year, and liabilities of RM325.1m falling due after that. Offsetting this, it had RM127.2m in cash and RM206.5m in receivables that were due within 12 months. So its liabilities total RM390.8m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of RM415.3m, so it does suggest shareholders should keep an eye on GuocoLand (Malaysia) 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.

See our latest analysis for GuocoLand (Malaysia) Berhad

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.

GuocoLand (Malaysia) Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (7.0), and fairly weak interest coverage, since EBIT is just 1.8 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, GuocoLand (Malaysia) Berhad saw its EBIT tank 38% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is GuocoLand (Malaysia) 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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, GuocoLand (Malaysia) Berhad actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, GuocoLand (Malaysia) Berhad's net debt to EBITDA left us tentative about the stock, and its EBIT growth rate 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. Overall, we think it's fair to say that GuocoLand (Malaysia) Berhad has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - GuocoLand (Malaysia) Berhad has 3 warning signs we think 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. 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.