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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that UMS Holdings Limited (SGX:558) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for UMS Holdings

What Is UMS Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that UMS Holdings had debt of S$17.9m at the end of March 2024, a reduction from S$21.2m over a year. However, it does have S$116.5m in cash offsetting this, leading to net cash of S$98.6m.

A Look At UMS Holdings' Liabilities

The latest balance sheet data shows that UMS Holdings had liabilities of S$55.3m due within a year, and liabilities of S$33.8m falling due after that. Offsetting this, it had S$116.5m in cash and S$51.7m in receivables that were due within 12 months. So it can boast S$79.0m 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.

It is just as well that UMS Holdings's load is not too heavy, because its EBIT was down 41% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 UMS Holdings 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While UMS Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, UMS Holdings recorded free cash flow worth 55% 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case UMS Holdings has S$98.6m in net cash and a decent-looking balance sheet. So we don't have any problem with UMS Holdings's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for UMS Holdings that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.