Is Land & General Berhad (KLSE:L&G) A Risky Investment?

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.' 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 can see that Land & General Berhad (KLSE:L&G) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

See our latest analysis for Land & General Berhad

How Much Debt Does Land & General Berhad Carry?

The chart below, which you can click on for greater detail, shows that Land & General Berhad had RM212.1m in debt in September 2021; about the same as the year before. However, because it has a cash reserve of RM108.4m, its net debt is less, at about RM103.8m.

How Healthy Is Land & General Berhad's Balance Sheet?

The latest balance sheet data shows that Land & General Berhad had liabilities of RM206.9m due within a year, and liabilities of RM220.3m falling due after that. On the other hand, it had cash of RM108.4m and RM86.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM232.0m.

This is a mountain of leverage relative to its market capitalization of RM312.2m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Land & General Berhad has a debt to EBITDA ratio of 3.4, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 12.7 is very high, suggesting that the interest expense on the debt is currently quite low. Importantly Land & General Berhad's EBIT was essentially flat over the last twelve months. We would prefer to see some earnings growth, because that always helps diminish debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Land & General Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Land & General 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

We'd go so far as to say Land & General Berhad's conversion of EBIT to free cash flow was disappointing. But on the bright side, its interest cover 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 Land & General Berhad stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Land & General Berhad (of which 1 is significant!) you should know about.

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. 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.