Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Sands China Ltd. (HKG:1928) does have debt on its balance sheet. 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 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Sands China's Net Debt?
The image below, which you can click on for greater detail, shows that at December 2021 Sands China had debt of US$7.84b, up from US$6.92b in one year. However, it also had US$678.0m in cash, and so its net debt is US$7.16b.
How Healthy Is Sands China's Balance Sheet?
According to the last reported balance sheet, Sands China had liabilities of US$1.09b due within 12 months, and liabilities of US$8.11b due beyond 12 months. Offsetting these obligations, it had cash of US$678.0m as well as receivables valued at US$183.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$8.35b.
Sands China has a very large market capitalization of US$23.9b, 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. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sands China's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year Sands China wasn't profitable at an EBIT level, but managed to grow its revenue by 70%, to US$2.9b. With any luck the company will be able to grow its way to profitability.
Despite the top line growth, Sands China still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at US$480m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$552m of cash over the last year. So suffice it to say we do consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Sands China is showing 2 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.