Does USP Group (SGX:BRS) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies USP Group Limited (SGX:BRS) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for USP Group

What Is USP Group's Debt?

You can click the graphic below for the historical numbers, but it shows that USP Group had S$35.7m of debt in December 2020, down from S$42.2m, one year before. On the flip side, it has S$5.26m in cash leading to net debt of about S$30.5m.

A Look At USP Group's Liabilities

According to the last reported balance sheet, USP Group had liabilities of S$38.5m due within 12 months, and liabilities of S$9.10m due beyond 12 months. Offsetting this, it had S$5.26m in cash and S$5.74m in receivables that were due within 12 months. So it has liabilities totalling S$36.6m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the S$6.84m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, USP Group would likely require a major re-capitalisation if it had to pay its creditors today.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

USP Group shareholders face the double whammy of a high net debt to EBITDA ratio (9.7), and fairly weak interest coverage, since EBIT is just 0.63 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for USP Group is that it turned last year's EBIT loss into a gain of S$897k, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is USP Group'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 it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, USP Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, USP Group's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We're quite clear that we consider USP Group to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. To that end, you should learn about the 4 warning signs we've spotted with USP Group (including 3 which are significant) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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