We Think Singapore Technologies Engineering (SGX:S63) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Singapore Technologies Engineering Ltd (SGX:S63) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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

View our latest analysis for Singapore Technologies Engineering

How Much Debt Does Singapore Technologies Engineering Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Singapore Technologies Engineering had S$6.17b of debt, an increase on S$2.03b, over one year. On the flip side, it has S$533.3m in cash leading to net debt of about S$5.64b.

How Strong Is Singapore Technologies Engineering's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Singapore Technologies Engineering had liabilities of S$7.52b due within 12 months and liabilities of S$4.52b due beyond that. On the other hand, it had cash of S$533.3m and S$3.23b worth of receivables due within a year. So its liabilities total S$8.28b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of S$10.9b, so it does suggest shareholders should keep an eye on Singapore Technologies Engineering's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

As it happens Singapore Technologies Engineering has a fairly concerning net debt to EBITDA ratio of 5.6 but very strong interest coverage of 11.3. So either it has access to very cheap long term debt or that interest expense is going to grow! Importantly Singapore Technologies Engineering's EBIT was essentially flat over the last twelve months. We would prefer to see some earnings growth, because that always helps diminish 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 Singapore Technologies Engineering'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Singapore Technologies Engineering recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Both Singapore Technologies Engineering's ability to to convert EBIT to free cash flow and its interest cover gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle handle its debt, based on its EBITDA,. Looking at all this data makes us feel a little cautious about Singapore Technologies Engineering's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Singapore Technologies Engineering you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.