Here's Why GuocoLand (Malaysia) Berhad (KLSE:GUOCO) 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.' 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. As with many other companies GuocoLand (Malaysia) Berhad (KLSE:GUOCO) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for GuocoLand (Malaysia) Berhad

How Much Debt Does GuocoLand (Malaysia) Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that GuocoLand (Malaysia) Berhad had RM941.4m of debt in December 2020, down from RM1.20b, one year before. On the flip side, it has RM205.7m in cash leading to net debt of about RM735.7m.

How Strong Is GuocoLand (Malaysia) Berhad's Balance Sheet?

We can see from the most recent balance sheet that GuocoLand (Malaysia) Berhad had liabilities of RM517.4m falling due within a year, and liabilities of RM664.1m due beyond that. Offsetting this, it had RM205.7m in cash and RM154.9m in receivables that were due within 12 months. So its liabilities total RM820.9m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the RM415.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, GuocoLand (Malaysia) Berhad would likely require a major re-capitalisation if it had to pay its creditors today.

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).

With a net debt to EBITDA ratio of 7.9, it's fair to say GuocoLand (Malaysia) Berhad does have a significant amount of debt. However, its interest coverage of 2.5 is reasonably strong, which is a good sign. The silver lining is that GuocoLand (Malaysia) Berhad grew its EBIT by 2,794% last year, which nourishing like the idealism of youth. If that earnings trend continues it will make its debt load much more manageable in the future. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since GuocoLand (Malaysia) 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the most recent two years, GuocoLand (Malaysia) Berhad recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

While GuocoLand (Malaysia) Berhad's level of total liabilities has us nervous. To wit both its EBIT growth rate and conversion of EBIT to free cash flow were encouraging signs. When we consider all the factors discussed, it seems to us that GuocoLand (Malaysia) Berhad is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. We've identified 2 warning signs with GuocoLand (Malaysia) Berhad , and understanding them should be part of your investment process.

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.

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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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