Is Singapore Technologies Engineering (SGX:S63) Using Too Much Debt?

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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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Singapore Technologies Engineering Ltd (SGX:S63) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Singapore Technologies Engineering

How Much Debt Does Singapore Technologies Engineering Carry?

The image below, which you can click on for greater detail, shows that Singapore Technologies Engineering had debt of S$807.7m at the end of March 2019, a reduction from S$1.04b over a year. However, it does have S$609.0m in cash offsetting this, leading to net debt of about S$198.7m.

A Look At Singapore Technologies Engineering's Liabilities

We can see from the most recent balance sheet that Singapore Technologies Engineering had liabilities of S$3.77b falling due within a year, and liabilities of S$1.60b due beyond that. Offsetting these obligations, it had cash of S$609.0m as well as receivables valued at S$2.15b due within 12 months. So it has liabilities totalling S$2.62b more than its cash and near-term receivables, combined.

Given Singapore Technologies Engineering has a market capitalization of S$13.1b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Since Singapore Technologies Engineering does have net debt, we think it is worthwhile for shareholders to keep an eye on the balance sheet, over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Singapore Technologies Engineering's net debt is only 0.24 times its EBITDA. And its EBIT covers its interest expense a whopping 23.6 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Singapore Technologies Engineering grew its EBIT by 7.2% in the last year, making that debt load look even more manageable. 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 Singapore Technologies Engineering 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Singapore Technologies Engineering produced sturdy free cash flow equating to 79% 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.

Our View

Singapore Technologies Engineering's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Looking at the bigger picture, we think Singapore Technologies Engineering's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Given Singapore Technologies Engineering has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.