Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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. Importantly, Second Chance Properties Ltd (SGX:528) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Second Chance Properties's Debt?
As you can see below, at the end of November 2019, Second Chance Properties had S$19.3m of debt, up from S$37.6 a year ago. Click the image for more detail. However, it does have S$33.3m in cash offsetting this, leading to net cash of S$14.0m.
How Healthy Is Second Chance Properties's Balance Sheet?
The latest balance sheet data shows that Second Chance Properties had liabilities of S$22.2m due within a year, and liabilities of S$587.0k falling due after that. Offsetting this, it had S$33.3m in cash and S$449.0k in receivables that were due within 12 months. So it actually has S$11.0m more liquid assets than total liabilities.
This surplus suggests that Second Chance Properties has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Second Chance Properties boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Second Chance Properties saw its EBIT drop by 4.8% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Second Chance Properties 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Second Chance Properties 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, Second Chance Properties actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While we empathize with investors who find debt concerning, you should keep in mind that Second Chance Properties has net cash of S$14.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of S$8.8m, being 107% of its EBIT. So is Second Chance Properties'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. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Second Chance Properties (of which 1 makes us a bit uncomfortable!) you should know about.
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.
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.
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