Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 ISDN Holdings Limited (SGX:I07) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is ISDN Holdings's Debt?
As you can see below, at the end of March 2019, ISDN Holdings had S$29.5m of debt, up from S$13.3m a year ago. Click the image for more detail. But on the other hand it also has S$43.4m in cash, leading to a S$13.9m net cash position.
How Strong Is ISDN Holdings's Balance Sheet?
The latest balance sheet data shows that ISDN Holdings had liabilities of S$81.6m due within a year, and liabilities of S$12.6m falling due after that. Offsetting these obligations, it had cash of S$43.4m as well as receivables valued at S$104.0m due within 12 months. So it actually has S$53.3m more liquid assets than total liabilities.
This surplus liquidity suggests that ISDN Holdings's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, it seems its balance sheet is as strong as a black-belt karate master. Succinctly put, ISDN Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, ISDN Holdings grew its EBIT by 5.1% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine ISDN Holdings'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. ISDN Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, ISDN Holdings's free cash flow amounted to 36% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While it is always sensible to investigate a company's debt, in this case ISDN Holdings has S$14m in net cash and a decent-looking balance sheet. And it also grew its EBIT by 5.1% over the last year. So we don't think ISDN Holdings's use of debt is risky. We'd be very excited to see if ISDN Holdings 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.
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.
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