Is Unisem (M) Berhad (KLSE:UNISEM) Using Too Much Debt?

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.' 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. As with many other companies Unisem (M) Berhad (KLSE:UNISEM) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Unisem (M) Berhad

How Much Debt Does Unisem (M) Berhad Carry?

As you can see below, at the end of June 2022, Unisem (M) Berhad had RM197.0m of debt, up from RM183.8m a year ago. Click the image for more detail. However, it does have RM627.6m in cash offsetting this, leading to net cash of RM430.6m.

How Strong Is Unisem (M) Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Unisem (M) Berhad had liabilities of RM500.8m due within 12 months and liabilities of RM146.4m due beyond that. Offsetting these obligations, it had cash of RM627.6m as well as receivables valued at RM241.8m due within 12 months. So it can boast RM222.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Unisem (M) Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Unisem (M) Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Unisem (M) Berhad has increased its EBIT by 5.4% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Unisem (M) Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Unisem (M) Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Unisem (M) Berhad burned a lot of cash. 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case Unisem (M) Berhad has RM430.6m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 5.4% in the last twelve months. So we don't have any problem with Unisem (M) Berhad's use of 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 2 warning signs for Unisem (M) Berhad (of which 1 is potentially serious!) you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.