South Port New Zealand (NZSE:SPN) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that South Port New Zealand Limited (NZSE:SPN) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for South Port New Zealand

What Is South Port New Zealand's Net Debt?

As you can see below, at the end of December 2020, South Port New Zealand had NZ$11.6m of debt, up from NZ$11.0m a year ago. Click the image for more detail. However, because it has a cash reserve of NZ$2.01m, its net debt is less, at about NZ$9.63m.

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

We can see from the most recent balance sheet that South Port New Zealand had liabilities of NZ$5.94m falling due within a year, and liabilities of NZ$12.0m due beyond that. On the other hand, it had cash of NZ$2.01m and NZ$8.56m worth of receivables due within a year. So it has liabilities totalling NZ$7.35m more than its cash and near-term receivables, combined.

Since publicly traded South Port New Zealand shares are worth a total of NZ$233.5m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

South Port New Zealand's net debt is only 0.49 times its EBITDA. And its EBIT easily covers its interest expense, being 31.8 times the size. So we're pretty relaxed about its super-conservative use of debt. Also good is that South Port New Zealand 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 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, South Port New Zealand recorded free cash flow worth 58% 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

The good news is that South Port New Zealand's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its net debt to EBITDA also supports that impression! It's also worth noting that South Port New Zealand is in the Infrastructure industry, which is often considered to be quite defensive. Looking at the bigger picture, we think South Port New Zealand's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of South Port New Zealand's earnings per share history for free.

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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