David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Silverlake Axis Ltd (SGX:5CP) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 Silverlake Axis's Debt?
As you can see below, Silverlake Axis had RM85.0k of debt at June 2019, down from RM28.3m a year prior. But it also has RM623.0m in cash to offset that, meaning it has RM622.9m net cash.
How Healthy Is Silverlake Axis's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Silverlake Axis had liabilities of RM222.3m due within 12 months and liabilities of RM367.7m due beyond that. Offsetting these obligations, it had cash of RM623.0m as well as receivables valued at RM207.7m due within 12 months. So it can boast RM240.6m more liquid assets than total liabilities.
This short term liquidity is a sign that Silverlake Axis could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Silverlake Axis has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Silverlake Axis has boosted its EBIT by 68%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Silverlake Axis's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Silverlake Axis 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, Silverlake Axis actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While it is always sensible to investigate a company's debt, in this case Silverlake Axis has RM622.9m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 105% of that EBIT to free cash flow, bringing in RM291m. So is Silverlake Axis's debt a risk? It doesn't seem so to us. We'd be very excited to see if Silverlake Axis insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
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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If you spot an error that warrants correction, please contact the editor at email@example.com. 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.