Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Sing Holdings Limited (SGX:5IC) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 think about a company's use of debt, we first look at cash and debt together.
What Is Sing Holdings's Debt?
As you can see below, Sing Holdings had S$158.4m of debt at June 2019, down from S$276.4m a year prior. However, it does have S$47.9m in cash offsetting this, leading to net debt of about S$110.4m.
How Healthy Is Sing Holdings's Balance Sheet?
The latest balance sheet data shows that Sing Holdings had liabilities of S$19.9m due within a year, and liabilities of S$171.9m falling due after that. Offsetting these obligations, it had cash of S$47.9m as well as receivables valued at S$28.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$115.7m.
This is a mountain of leverage relative to its market capitalization of S$160.4m. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).
Sing Holdings has net debt to EBITDA of 2.6 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 8.6 times its interest expense, and its net debt to EBITDA, was quite high, at 2.6. Pleasingly, Sing Holdings is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 152% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Sing Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Sing Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Sing Holdings's conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. We think that Sing Holdings's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.
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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