Frencken Group (SGX:E28) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that Frencken Group Limited (SGX:E28) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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

View our latest analysis for Frencken Group

What Is Frencken Group's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Frencken Group had debt of S$87.5m, up from S$81.7m in one year. However, it does have S$159.4m in cash offsetting this, leading to net cash of S$71.9m.

How Healthy Is Frencken Group's Balance Sheet?

We can see from the most recent balance sheet that Frencken Group had liabilities of S$254.3m falling due within a year, and liabilities of S$14.0m due beyond that. Offsetting these obligations, it had cash of S$159.4m as well as receivables valued at S$146.2m due within 12 months. So it actually has S$37.3m more liquid assets than total liabilities.

This surplus suggests that Frencken Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Frencken Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Frencken Group grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Frencken Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Frencken Group 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, Frencken Group generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Frencken Group has S$71.9m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in S$30m. So we don't think Frencken Group's use of debt is risky. Another factor that would give us confidence in Frencken Group would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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