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. 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. Importantly, ComfortDelGro Corporation Limited (SGX:C52) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. 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, 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.
How Much Debt Does ComfortDelGro Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 ComfortDelGro had S$633.8m of debt, an increase on S$447.2m, over one year. However, because it has a cash reserve of S$518.5m, its net debt is less, at about S$115.3m.
How Strong Is ComfortDelGro’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that ComfortDelGro had liabilities of S$1.11b due within 12 months and liabilities of S$1.25b due beyond that. Offsetting this, it had S$518.5m in cash and S$601.7m in receivables that were due within 12 months. So it has liabilities totalling S$1.24b more than its cash and near-term receivables, combined.
ComfortDelGro has a market capitalization of S$4.70b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
ComfortDelGro has a low net debt to EBITDA ratio of only 0.13. And its EBIT easily covers its interest expense, being 53.6 times the size. So we’re pretty relaxed about its super-conservative use of debt. Also good is that ComfortDelGro grew its EBIT at 11% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine ComfortDelGro’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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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, ComfortDelGro recorded free cash flow worth 61% 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.
The good news is that ComfortDelGro’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that’s just the beginning of the good news since its net debt to EBITDA is also very heartening. Taking all this data into account, it seems to us that ComfortDelGro takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check ComfortDelGro’s dividend history, without delay!
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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