Is Singapore Technologies Engineering (SGX:S63) Using Too Much Debt?
Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Singapore Technologies Engineering Ltd (SGX:S63) makes use of debt. But the real question is whether this debt is making the company risky.
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Singapore Technologies Engineering
What Is Singapore Technologies Engineering's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Singapore Technologies Engineering had S$1.62b of debt, an increase on S$1.02b, over one year. However, it also had S$321.7m in cash, and so its net debt is S$1.30b.
How Strong Is Singapore Technologies Engineering's Balance Sheet?
The latest balance sheet data shows that Singapore Technologies Engineering had liabilities of S$4.60b due within a year, and liabilities of S$1.87b falling due after that. Offsetting these obligations, it had cash of S$321.7m as well as receivables valued at S$2.47b due within 12 months. So it has liabilities totalling S$3.68b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Singapore Technologies Engineering has a market capitalization of S$11.9b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Singapore Technologies Engineering's net debt is only 1.5 times its EBITDA. And its EBIT covers its interest expense a whopping 37.5 times over. So we're pretty relaxed about its super-conservative use of debt. Fortunately, Singapore Technologies Engineering grew its EBIT by 5.9% 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 Singapore Technologies Engineering'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Singapore Technologies Engineering recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Happily, Singapore Technologies Engineering's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. All these things considered, it appears that Singapore Technologies Engineering can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Singapore Technologies Engineering's dividend history, without delay!
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 editorial-team@simplywallst.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.
