Tropicana Corporation Berhad (KLSE:TROP) Use Of Debt Could Be Considered Risky

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.' 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 Tropicana Corporation Berhad (KLSE:TROP) does have debt on its balance sheet. But is this debt a concern to shareholders?

We've discovered 1 warning sign about Tropicana Corporation Berhad. View them for free.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Tropicana Corporation Berhad Carry?

As you can see below, Tropicana Corporation Berhad had RM2.32b of debt at December 2024, down from RM3.21b a year prior. On the flip side, it has RM868.6m in cash leading to net debt of about RM1.45b.

A Look At Tropicana Corporation Berhad's Liabilities

According to the last reported balance sheet, Tropicana Corporation Berhad had liabilities of RM3.06b due within 12 months, and liabilities of RM2.30b due beyond 12 months. Offsetting this, it had RM868.6m in cash and RM920.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM3.57b.

When you consider that this deficiency exceeds the company's RM2.91b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

View our latest analysis for Tropicana Corporation Berhad

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.25 times and a disturbingly high net debt to EBITDA ratio of 22.1 hit our confidence in Tropicana Corporation Berhad like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even more troubling is the fact that Tropicana Corporation Berhad actually let its EBIT decrease by 9.2% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tropicana Corporation Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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 that EBIT is backed by free cash flow. Over the last two years, Tropicana Corporation Berhad saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Tropicana Corporation Berhad's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its level of total liabilities also fails to instill confidence. Taking into account all the aforementioned factors, it looks like Tropicana Corporation Berhad has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Tropicana Corporation Berhad , and understanding them should be part of your investment process.

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.

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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.