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United Overseas Australia (ASX:UOS) Seems To Use Debt Quite Sensibly

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Warren Buffett famously said, '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 note that United Overseas Australia Limited (ASX:UOS) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for United Overseas Australia

How Much Debt Does United Overseas Australia Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 United Overseas Australia had AU$249.8m of debt, an increase on AU$125.3m, over one year. However, its balance sheet shows it holds AU$718.4m in cash, so it actually has AU$468.6m net cash.

debt-equity-history-analysis
debt-equity-history-analysis

How Healthy Is United Overseas Australia's Balance Sheet?

We can see from the most recent balance sheet that United Overseas Australia had liabilities of AU$439.1m falling due within a year, and liabilities of AU$48.6m due beyond that. Offsetting this, it had AU$718.4m in cash and AU$175.6m in receivables that were due within 12 months. So it can boast AU$406.3m 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. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, United Overseas Australia boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that United Overseas Australia's load is not too heavy, because its EBIT was down 33% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since United Overseas Australia will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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. Over the last three years, United Overseas Australia actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case United Overseas Australia has AU$468.6m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of AU$161m, being 120% of its EBIT. So we don't think United Overseas Australia's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with United Overseas Australia (including 1 which is a bit concerning) .

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.

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.

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