Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, CapitaLand Limited (SGX:C31) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does CapitaLand Carry?
As you can see below, at the end of June 2019, CapitaLand had S$33.0b of debt, up from S$21.9b a year ago. Click the image for more detail. However, because it has a cash reserve of S$4.93b, its net debt is less, at about S$28.0b.
How Healthy Is CapitaLand's Balance Sheet?
The latest balance sheet data shows that CapitaLand had liabilities of S$13.0b due within a year, and liabilities of S$30.2b falling due after that. Offsetting these obligations, it had cash of S$4.93b as well as receivables valued at S$2.11b due within 12 months. So it has liabilities totalling S$36.1b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the S$18.3b 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, CapitaLand would probably need a major re-capitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).
CapitaLand has a rather high debt to EBITDA ratio of 13.7 which suggests a meaningful debt load. However, its interest coverage of 3.5 is reasonably strong, which is a good sign. Given the debt load, it's hardly ideal that CapitaLand's EBIT was pretty flat over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CapitaLand can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, CapitaLand actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
To be frank both CapitaLand's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the bigger picture, it seems clear to us that CapitaLand's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. Given CapitaLand has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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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