Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 United Overseas Australia Limited (ASX:UOS) does use debt in its business. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is United Overseas Australia's Debt?
The chart below, which you can click on for greater detail, shows that United Overseas Australia had AU$251.6m in debt in December 2021; about the same as the year before. However, its balance sheet shows it holds AU$698.2m in cash, so it actually has AU$446.6m net cash.
How Strong Is United Overseas Australia's Balance Sheet?
According to the last reported balance sheet, United Overseas Australia had liabilities of AU$454.9m due within 12 months, and liabilities of AU$27.1m due beyond 12 months. Offsetting this, it had AU$698.2m in cash and AU$205.3m in receivables that were due within 12 months. So it actually has AU$421.5m more liquid assets than total liabilities.
This surplus liquidity suggests that United Overseas Australia's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, United Overseas Australia boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for United Overseas Australia if management cannot prevent a repeat of the 25% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is United Overseas Australia's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While United Overseas Australia 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. Happily for any shareholders, United Overseas Australia actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While it is always sensible to investigate a company's debt, in this case United Overseas Australia has AU$446.6m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 108% of that EBIT to free cash flow, bringing in AU$113m. So is United Overseas Australia'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. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with United Overseas Australia (at least 1 which is significant) , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.