Here's Why Malaysia Airports Holdings Berhad (KLSE:AIRPORT) Can Manage Its Debt Responsibly

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.' 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. We can see that Malaysia Airports Holdings Berhad (KLSE:AIRPORT) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Malaysia Airports Holdings Berhad

What Is Malaysia Airports Holdings Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Malaysia Airports Holdings Berhad had RM6.44b of debt, an increase on RM4.68b, over one year. On the flip side, it has RM3.80b in cash leading to net debt of about RM2.65b.

How Healthy Is Malaysia Airports Holdings Berhad's Balance Sheet?

We can see from the most recent balance sheet that Malaysia Airports Holdings Berhad had liabilities of RM4.22b falling due within a year, and liabilities of RM10.0b due beyond that. Offsetting this, it had RM3.80b in cash and RM554.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM9.91b.

This is a mountain of leverage relative to its market capitalization of RM10.9b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

While Malaysia Airports Holdings Berhad has a quite reasonable net debt to EBITDA multiple of 1.6, its interest cover seems weak, at 1.5. This does have us wondering if the company pays high interest because it is considered risky. In any case, it's safe to say the company has meaningful debt. Pleasingly, Malaysia Airports Holdings Berhad is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 257% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Malaysia Airports Holdings 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent two years, Malaysia Airports Holdings Berhad recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

When it comes to the balance sheet, the standout positive for Malaysia Airports Holdings Berhad was the fact that it seems able to grow its EBIT confidently. However, our other observations weren't so heartening. To be specific, it seems about as good at covering its interest expense with its EBIT as wet socks are at keeping your feet warm. We would also note that Infrastructure industry companies like Malaysia Airports Holdings Berhad commonly do use debt without problems. Looking at all this data makes us feel a little cautious about Malaysia Airports Holdings Berhad's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. While Malaysia Airports Holdings Berhad didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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.