These 4 Measures Indicate That Frencken Group (SGX:E28) Is Using Debt Safely

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.' 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 can see that Frencken Group Limited (SGX:E28) does use debt in its business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Frencken Group

How Much Debt Does Frencken Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Frencken Group had S$97.2m of debt, an increase on S$67.3m, over one year. However, its balance sheet shows it holds S$194.4m in cash, so it actually has S$97.2m net cash.

How Healthy Is Frencken Group's Balance Sheet?

We can see from the most recent balance sheet that Frencken Group had liabilities of S$288.4m falling due within a year, and liabilities of S$20.7m due beyond that. On the other hand, it had cash of S$194.4m and S$127.8m worth of receivables due within a year. So it can boast S$13.1m 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. Simply put, the fact that Frencken Group has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Frencken Group has boosted its EBIT by 33%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Frencken Group can strengthen its balance sheet over time. 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. Frencken Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Frencken Group recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Frencken Group has net cash of S$97.2m, as well as more liquid assets than liabilities. The cherry on top was that in converted 95% of that EBIT to free cash flow, bringing in S$23m. So is Frencken Group's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 2 warning signs for Frencken Group that you should be aware of before investing here.

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. 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.