Here’s why IOI Corporation Berhad (KLSE:IOICORP) can manage its debt responsibly
Warren Buffett said: “Volatility is far from synonymous with risk. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that IOI Corporation Berhad (KLSE: IOICORP) uses debt in its business. But should shareholders worry about its use of debt?
What risk does debt carry?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
See our latest analysis for IOI Corporation Berhad
What is the net debt of IOI Corporation Berhad?
The graph below, which you can click on for more details, shows that IOI Corporation Berhad had a debt of RM4.72 billion in September 2021; about the same as the previous year. On the other hand, he has RM2.20 billion in cash, resulting in a net debt of around RM2.51 billion.
A look at the liabilities of IOI Corporation Berhad
The latest balance sheet data shows that IOI Corporation Berhad had liabilities of RM5.07 billion due within one year, and liabilities of RM2.33 billion falling due thereafter. In return, he had RM2.20 billion in cash and RM1.51 billion in receivables due within 12 months. It therefore has liabilities totaling RM3.68 billion more than its cash and short-term receivables, combined.
Given that IOI Corporation Berhad has a market capitalization of RM28.6 billion, it is hard to believe that these liabilities pose a big threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
We would say that IOI Corporation Berhad’s moderate net debt to EBITDA ratio (1.5) indicates prudence in leverage. And its strong interest coverage of 10.9 times puts us even more at ease. On top of that, IOI Corporation Berhad has grown its EBIT by 37% over the last twelve months, and this growth will make it easier to manage its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine IOI Corporation Berhad’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, IOI Corporation Berhad has produced strong free cash flow equivalent to 59% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
IOI Corporation Berhad’s EBIT growth rate suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And that’s just the beginning of the good news as his interest coverage is also very pleasing. Zooming out, IOI Corporation Berhad appears to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. To do this, you need to find out about the 2 warning signs we spotted some with IOI Corporation Berhad (including 1 that is potentially serious).
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.