David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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 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 A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is UMS Holdings's Net Debt?
As you can see below, at the end of June 2019, UMS Holdings had S$59.7m of debt, up from S$13.9m a year ago. Click the image for more detail. However, it does have S$60.7m in cash offsetting this, leading to net cash of S$1.07m.
How Healthy Is UMS Holdings's Balance Sheet?
The latest balance sheet data shows that UMS Holdings had liabilities of S$70.8m due within a year, and liabilities of S$10.4m falling due after that. On the other hand, it had cash of S$60.7m and S$15.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$4.71m.
Having regard to UMS Holdings's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the S$324.5m company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, UMS Holdings also has more cash than debt, so we're pretty confident 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 47% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to look at a company's total liabilities, it is very reassuring that UMS Holdings has S$1.07m in net cash. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in S$33m. So we don't have any problem with UMS Holdings's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that UMS Holdings insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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