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Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Brook Crompton Holdings Ltd. (SGX:AWC) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Brook Crompton Holdings’s Debt?
You can click the graphic below for the historical numbers, but it shows that Brook Crompton Holdings had S$1.42m of debt in March 2019, down from S$1.64m, one year before But on the other hand it also has S$17.2m in cash, leading to a S$15.8m net cash position.
How Strong Is Brook Crompton Holdings’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Brook Crompton Holdings had liabilities of S$12.9m due within 12 months and liabilities of S$2.85m due beyond that. On the other hand, it had cash of S$17.2m and S$11.0m worth of receivables due within a year. So it actually has S$12.4m more liquid assets than total liabilities.
This excess liquidity is a great indication that Brook Crompton Holdings’s balance sheet is just as strong as racists are weak. On this view, it seems its balance sheet is as strong as a black-belt karate master. Given that Brook Crompton Holdings has more cash than debt, we’re pretty confident it can manage its debt safely.
Also positive, Brook Crompton Holdings grew its EBIT by 30% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can’t view debt in total isolation; since Brook Crompton Holdings will need earnings to service that debt. 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Brook Crompton 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. Happily for any shareholders, Brook Crompton Holdings actually produced more free cash flow than EBIT over the last three years. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
While we empathize with investors who find debt concerning, you should keep in mind that Brook Crompton Holdings has net cash of S$16m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of S$4.4m, being 106% of its EBIT. The bottom line is that Brook Crompton Holdings’s use of debt is absolutely fine. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you’ve also come to that realization, you’re in luck, because today you can view this interactive graph of Brook Crompton Holdings’s earnings per share history for free.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.