The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, TA Corporation Ltd (SGX:PA3) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does TA Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 TA had S$373.8m of debt, an increase on S$347.4m, over one year. However, it does have S$29.5m in cash offsetting this, leading to net debt of about S$344.3m.
How Strong Is TA's Balance Sheet?
The latest balance sheet data shows that TA had liabilities of S$296.9m due within a year, and liabilities of S$271.0m falling due after that. Offsetting these obligations, it had cash of S$29.5m as well as receivables valued at S$84.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$453.9m.
This deficit casts a shadow over the S$95.8m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt At the end of the day, TA would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is TA's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
In the last year TA had negative earnings before interest and tax, and actually shrunk its revenue by 26%, to S$138m. That makes us nervous, to say the least.
While TA's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at S$4.7m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through S$39m in the last year. So we think this stock is risky, like walking through a dirty dog park with a mask on. For riskier companies like TA I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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