Health Check: How Prudently Does Sembcorp Marine (SGX:S51) Use 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.' 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 Sembcorp Marine Ltd (SGX:S51) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sembcorp Marine

What Is Sembcorp Marine's Debt?

As you can see below, Sembcorp Marine had S$3.55b of debt at December 2020, down from S$4.41b a year prior. However, it does have S$806.3m in cash offsetting this, leading to net debt of about S$2.74b.

A Look At Sembcorp Marine's Liabilities

According to the last reported balance sheet, Sembcorp Marine had liabilities of S$3.40b due within 12 months, and liabilities of S$1.87b due beyond 12 months. Offsetting this, it had S$806.3m in cash and S$2.19b in receivables that were due within 12 months. So it has liabilities totalling S$2.28b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's S$1.91b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sembcorp Marine 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.

In the last year Sembcorp Marine had a loss before interest and tax, and actually shrunk its revenue by 48%, to S$1.5b. That makes us nervous, to say the least.

Caveat Emptor

Not only did Sembcorp Marine's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable S$582m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through S$842m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Sembcorp Marine is showing 2 warning signs in our investment analysis , you should know about...

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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