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 Sunningdale Tech Ltd (SGX:BHQ) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Sunningdale Tech Carry?
The chart below, which you can click on for greater detail, shows that Sunningdale Tech had S$101.0m in debt in June 2020; about the same as the year before. But it also has S$130.7m in cash to offset that, meaning it has S$29.7m net cash.
How Healthy Is Sunningdale Tech's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Sunningdale Tech had liabilities of S$274.8m due within 12 months and liabilities of S$56.5m due beyond that. On the other hand, it had cash of S$130.7m and S$231.6m worth of receivables due within a year. So it actually has S$31.1m more liquid assets than total liabilities.
This short term liquidity is a sign that Sunningdale Tech could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Sunningdale Tech boasts net cash, so it's fair to say it does not have a heavy debt load!
One way Sunningdale Tech could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 13%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sunningdale Tech can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Sunningdale Tech has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Sunningdale Tech produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Sunningdale Tech has S$29.7m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in S$49m. So we don't think Sunningdale Tech's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Sunningdale Tech is showing 2 warning signs in our investment analysis , you should know about...
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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