Is South Port New Zealand (NZSE:SPN) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that South Port New Zealand Limited (NZSE:SPN) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 South Port New Zealand

How Much Debt Does South Port New Zealand Carry?

You can click the graphic below for the historical numbers, but it shows that South Port New Zealand had NZ$7.25m of debt in June 2020, down from NZ$7.60m, one year before. However, it does have NZ$1.23m in cash offsetting this, leading to net debt of about NZ$6.02m.

How Strong Is South Port New Zealand's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that South Port New Zealand had liabilities of NZ$7.66m due within 12 months and liabilities of NZ$6.12m due beyond that. Offsetting these obligations, it had cash of NZ$1.23m as well as receivables valued at NZ$6.41m due within 12 months. So it has liabilities totalling NZ$6.13m more than its cash and near-term receivables, combined.

Of course, South Port New Zealand has a market capitalization of NZ$198.1m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

South Port New Zealand's net debt is only 0.34 times its EBITDA. And its EBIT easily covers its interest expense, being 24.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, South Port New Zealand saw its EBIT drop by 3.5% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since South Port New Zealand 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, South Port New Zealand recorded free cash flow worth 54% 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.

Our View

Happily, South Port New Zealand's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its EBIT growth rate does undermine this impression a bit. It's also worth noting that South Port New Zealand is in the Infrastructure industry, which is often considered to be quite defensive. Taking all this data into account, it seems to us that South Port New Zealand 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 South Port New Zealand's dividend history, without delay!

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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. 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.
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