Here's Why UEM Sunrise Berhad (KLSE:UEMS) Is Weighed Down By Its Debt Load

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. Importantly, UEM Sunrise Berhad (KLSE:UEMS) does carry debt. But is this debt a concern to shareholders?

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 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, 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for UEM Sunrise Berhad

What Is UEM Sunrise Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that UEM Sunrise Berhad had debt of RM4.23b at the end of September 2021, a reduction from RM4.47b over a year. However, because it has a cash reserve of RM932.9m, its net debt is less, at about RM3.29b.

How Healthy Is UEM Sunrise Berhad's Balance Sheet?

We can see from the most recent balance sheet that UEM Sunrise Berhad had liabilities of RM1.87b falling due within a year, and liabilities of RM4.29b due beyond that. Offsetting this, it had RM932.9m in cash and RM978.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM4.24b.

This deficit casts a shadow over the RM1.85b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, UEM Sunrise Berhad would probably need a major re-capitalization if its creditors were to demand repayment.

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).

UEM Sunrise Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (33.6), and fairly weak interest coverage, since EBIT is just 0.46 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, UEM Sunrise Berhad saw its EBIT tank 66% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine UEM Sunrise Berhad's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, UEM Sunrise Berhad actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, UEM Sunrise Berhad's EBIT growth rate left us tentative about the stock, and its level of total liabilities 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. Taking into account all the aforementioned factors, it looks like UEM Sunrise Berhad has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with UEM Sunrise Berhad .

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.