We Think Serendip HoldingsLtd (TSE:7318) Can Stay On Top Of Its Debt

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.' 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, Serendip Holdings Co.,Ltd. (TSE:7318) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Serendip HoldingsLtd

How Much Debt Does Serendip HoldingsLtd Carry?

As you can see below, at the end of March 2024, Serendip HoldingsLtd had JP¥7.03b of debt, up from JP¥6.21b a year ago. Click the image for more detail. However, it does have JP¥3.95b in cash offsetting this, leading to net debt of about JP¥3.08b.

A Look At Serendip HoldingsLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Serendip HoldingsLtd had liabilities of JP¥7.61b due within 12 months and liabilities of JP¥6.41b due beyond that. Offsetting these obligations, it had cash of JP¥3.95b as well as receivables valued at JP¥3.62b due within 12 months. So its liabilities total JP¥6.44b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of JP¥7.73b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Serendip HoldingsLtd's net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its strong interest cover of 1k times, makes us even more comfortable. It is well worth noting that Serendip HoldingsLtd's EBIT shot up like bamboo after rain, gaining 58% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Serendip HoldingsLtd'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.

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. Happily for any shareholders, Serendip HoldingsLtd 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.

Our View

The good news is that Serendip HoldingsLtd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. When we consider the range of factors above, it looks like Serendip HoldingsLtd is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for Serendip HoldingsLtd that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.