Is Axiata Group Berhad (KLSE:AXIATA) Using Too Much Debt?

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. As with many other companies Axiata Group Berhad (KLSE:AXIATA) makes use of debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Axiata Group Berhad

What Is Axiata Group Berhad's Net Debt?

The chart below, which you can click on for greater detail, shows that Axiata Group Berhad had RM18.1b in debt in June 2021; about the same as the year before. However, because it has a cash reserve of RM6.79b, its net debt is less, at about RM11.3b.

How Strong Is Axiata Group Berhad's Balance Sheet?

We can see from the most recent balance sheet that Axiata Group Berhad had liabilities of RM16.9b falling due within a year, and liabilities of RM27.2b due beyond that. Offsetting this, it had RM6.79b in cash and RM4.41b in receivables that were due within 12 months. So it has liabilities totalling RM32.9b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of RM35.0b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Axiata Group Berhad has a very low debt to EBITDA ratio of 1.2 so it is strange to see weak interest coverage, with last year's EBIT being only 2.1 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. If Axiata Group Berhad can keep growing EBIT at last year's rate of 11% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Axiata Group Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Axiata Group Berhad recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over Axiata Group Berhad's attempt at covering its interest expense with its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Once we consider all the factors above, together, it seems to us that Axiata Group Berhad's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. For example, we've discovered 3 warning signs for Axiata Group Berhad (2 are potentially serious!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.

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