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.’ 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, SATS Ltd. (SGX:S58) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is SATS’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 SATS had S$414.9m of debt, an increase on S$95.4m, over one year. But on the other hand it also has S$549.2m in cash, leading to a S$134.3m net cash position.
How Healthy Is SATS’s Balance Sheet?
The latest balance sheet data shows that SATS had liabilities of S$562.2m due within a year, and liabilities of S$642.1m falling due after that. Offsetting this, it had S$549.2m in cash and S$388.8m in receivables that were due within 12 months. So its liabilities total S$266.3m more than the combination of its cash and short-term receivables.
Given SATS has a market capitalization of S$3.06b, it’s hard to believe these liabilities pose much threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, SATS boasts net cash, so it’s fair to say it does not have a heavy debt load!
But the other side of the story is that SATS saw its EBIT decline by 8.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 SATS 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. While SATS has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, SATS produced sturdy free cash flow equating to 75% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
We could understand if investors are concerned about SATS’s liabilities, but we can be reassured by the fact it has has net cash of S$134.3m. And it impressed us with free cash flow of S$168m, being 75% of its EBIT. So we don’t think SATS’s use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We’ve identified 1 warning sign with SATS , and understanding them should be part of your investment process.
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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