UMS Holdings (SGX:558) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 UMS Holdings Limited (SGX:558) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for UMS Holdings

What Is UMS Holdings's Debt?

As you can see below, UMS Holdings had S$19.6m of debt at June 2023, down from S$30.7m a year prior. However, its balance sheet shows it holds S$72.9m in cash, so it actually has S$53.3m net cash.

A Look At UMS Holdings' Liabilities

The latest balance sheet data shows that UMS Holdings had liabilities of S$67.3m due within a year, and liabilities of S$36.6m falling due after that. Offsetting these obligations, it had cash of S$72.9m as well as receivables valued at S$62.5m due within 12 months. So it can boast S$31.5m more liquid assets than total liabilities.

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

On the other hand, UMS Holdings saw its EBIT drop by 3.3% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 UMS Holdings'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. UMS Holdings 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, UMS Holdings produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case UMS Holdings has S$53.3m in net cash and a decent-looking balance sheet. So is UMS Holdings's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that UMS Holdings is showing 1 warning sign in our investment analysis , you should know about...

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.