The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Kingsmen Creatives Ltd. (SGX:5MZ) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Kingsmen Creatives Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Kingsmen Creatives had S$34.8m of debt, an increase on S$26.0m, over one year. But on the other hand it also has S$68.9m in cash, leading to a S$34.1m net cash position.
A Look At Kingsmen Creatives's Liabilities
We can see from the most recent balance sheet that Kingsmen Creatives had liabilities of S$130.2m falling due within a year, and liabilities of S$30.9m due beyond that. Offsetting these obligations, it had cash of S$68.9m as well as receivables valued at S$121.7m due within 12 months. So it can boast S$29.4m more liquid assets than total liabilities.
This excess liquidity suggests that Kingsmen Creatives is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Kingsmen Creatives boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Kingsmen Creatives grew its EBIT by 31% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Kingsmen Creatives's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Kingsmen Creatives 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, Kingsmen Creatives recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
While we empathize with investors who find debt concerning, you should keep in mind that Kingsmen Creatives has net cash of S$34.1m, as well as more liquid assets than liabilities. And we liked the look of last year's 31% year-on-year EBIT growth. So is Kingsmen Creatives's debt a risk? It doesn't seem so to us. Given Kingsmen Creatives has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.