Tropicana Corporation Berhad (KLSE:TROP) Seems To Be Using A Lot 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.' 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. Importantly, Tropicana Corporation Berhad (KLSE:TROP) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Tropicana Corporation Berhad

How Much Debt Does Tropicana Corporation Berhad Carry?

The image below, which you can click on for greater detail, shows that at December 2021 Tropicana Corporation Berhad had debt of RM4.09b, up from RM3.77b in one year. However, it does have RM785.1m in cash offsetting this, leading to net debt of about RM3.30b.

How Strong Is Tropicana Corporation Berhad's Balance Sheet?

The latest balance sheet data shows that Tropicana Corporation Berhad had liabilities of RM1.64b due within a year, and liabilities of RM4.76b falling due after that. On the other hand, it had cash of RM785.1m and RM793.2m worth of receivables due within a year. So it has liabilities totalling RM4.82b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the RM1.77b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Tropicana Corporation Berhad would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Weak interest cover of 0.61 times and a disturbingly high net debt to EBITDA ratio of 21.9 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. Worse, Tropicana Corporation Berhad's EBIT was down 51% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tropicana Corporation Berhad will need earnings to service that debt. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three 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

To be frank both Tropicana Corporation Berhad's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. It looks to us like Tropicana Corporation Berhad carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. 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. Be aware that Tropicana Corporation Berhad is showing 3 warning signs in our investment analysis , and 2 of those are significant...

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.