Universal Music Group (AMS:UMG) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Universal Music Group N.V. (AMS:UMG) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Universal Music Group

What Is Universal Music Group's Net Debt?

As you can see below, Universal Music Group had €2.10b of debt at December 2023, down from €2.25b a year prior. On the flip side, it has €504.0m in cash leading to net debt of about €1.60b.

How Healthy Is Universal Music Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Universal Music Group had liabilities of €6.27b due within 12 months and liabilities of €3.84b due beyond that. On the other hand, it had cash of €504.0m and €2.28b worth of receivables due within a year. So it has liabilities totalling €7.32b more than its cash and near-term receivables, combined.

Since publicly traded Universal Music Group shares are worth a very impressive total of €51.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Universal Music Group's net debt is only 1.1 times its EBITDA. And its EBIT covers its interest expense a whopping 16.6 times over. So we're pretty relaxed about its super-conservative use of debt. But the bad news is that Universal Music Group has seen its EBIT plunge 13% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Universal Music Group 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.

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. Over the last three years, Universal Music Group recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

The good news is that Universal Music Group's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its EBIT growth rate. All these things considered, it appears that Universal Music Group can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. We've identified 1 warning sign with Universal Music Group , and understanding them should be part of your investment process.

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.

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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.