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. 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. As with many other companies Frencken Group Limited (SGX:E28) makes use of debt. But the more important question is: how much risk is that debt creating?
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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Frencken Group Carry?
You can click the graphic below for the historical numbers, but it shows that Frencken Group had S$61.5m of debt in September 2019, down from S$78.7m, one year before. But it also has S$79.8m in cash to offset that, meaning it has S$18.3m net cash.
How Strong Is Frencken Group's Balance Sheet?
According to the last reported balance sheet, Frencken Group had liabilities of S$189.4m due within 12 months, and liabilities of S$16.2m due beyond 12 months. Offsetting these obligations, it had cash of S$79.8m as well as receivables valued at S$126.8m due within 12 months. So these liquid assets roughly match the total liabilities.
Having regard to Frencken Group's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the S$363.2m company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Frencken Group boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Frencken Group has boosted its EBIT by 69%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Frencken Group'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 Frencken Group 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. In the last three years, Frencken Group's free cash flow amounted to 39% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While we empathize with investors who find debt concerning, you should keep in mind that Frencken Group has net cash of S$18.3m, as well as more liquid assets than liabilities. And we liked the look of last year's 69% year-on-year EBIT growth. So we don't think Frencken Group's use of debt is risky. We'd be very excited to see if Frencken Group 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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