Is IOI Corporation Berhad (KLSE:IOICORP) a risky investment?
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. Like many other companies IOI Corporation Berhad (KLSE:IOICORP) uses debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for IOI Corporation Berhad
What is the debt of IOI Corporation Berhad?
As you can see below, at the end of March 2022, IOI Corporation Berhad had a debt of RM5.07 billion, compared to RM4.81 billion a year ago. Click on the image for more details. However, he also had RM2.45 billion in cash, so his net debt is RM2.62 billion.
How strong is IOI Corporation Berhad’s balance sheet?
According to the latest published balance sheet, IOI Corporation Berhad had liabilities of RM4.23 billion due within 12 months and liabilities of RM3.85 billion due beyond 12 months. As compensation for these obligations, it had cash of RM2.45 billion as well as receivables valued at RM1.96 billion and 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 listed shares are worth a total of RM26.5 billion, it seems unlikely that this level of liability is a major threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
IOI Corporation Berhad has a low net debt to EBITDA ratio of just 1.1. And its EBIT easily covers its interest charges, which is 15.7 times the size. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. On top of that, IOI Corporation Berhad has grown its EBIT by 95% in 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 ultimately, the company’s future profitability will decide whether IOI Corporation Berhad can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, IOI Corporation Berhad has recorded free cash flow of 51% of its EBIT, which is about normal given that free cash flow excludes interest and taxes. 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 interest coverage suggests they can manage their debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And this is only the beginning of good news since its EBIT growth rate is also very encouraging. Overall, we think IOI Corporation Berhad’s use of debt seems entirely reasonable and we are not concerned about that. After all, reasonable leverage can increase return on equity. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for IOI Corporation Berhad (1 of which makes us a little uncomfortable!) that you should know.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
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.