These 4 Measures Indicate That Keong Hong Holdings (SGX:5TT) Is Using Debt Extensively

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Keong Hong Holdings Limited (SGX:5TT) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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, 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Keong Hong Holdings

What Is Keong Hong Holdings's Debt?

As you can see below, at the end of September 2020, Keong Hong Holdings had S$136.2m of debt, up from S$124.7m a year ago. Click the image for more detail. However, it also had S$40.0m in cash, and so its net debt is S$96.2m.

How Strong Is Keong Hong Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Keong Hong Holdings had liabilities of S$142.4m due within 12 months and liabilities of S$62.1m due beyond that. On the other hand, it had cash of S$40.0m and S$129.9m worth of receivables due within a year. So it has liabilities totalling S$34.6m more than its cash and near-term receivables, combined.

Keong Hong Holdings has a market capitalization of S$76.4m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 7.4, it's fair to say Keong Hong Holdings does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 6.4 times, suggesting it can responsibly service its obligations. Importantly, Keong Hong Holdings's EBIT fell a jaw-dropping 47% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is Keong Hong Holdings'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Keong Hong Holdings recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Keong Hong Holdings's EBIT growth rate and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. When we consider all the factors discussed, it seems to us that Keong Hong Holdings is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. Case in point: We've spotted 4 warning signs for Keong Hong Holdings you should be aware of, and 2 of them shouldn't be ignored.

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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