Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ 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. Importantly, Chasen Holdings Limited (SGX:5NV) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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 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.
How Much Debt Does Chasen Holdings Carry?
As you can see below, at the end of June 2019, Chasen Holdings had S$35.4m of debt, up from S$33.9m a year ago. Click the image for more detail. However, it also had S$10.6m in cash, and so its net debt is S$24.8m.
A Look At Chasen Holdings’s Liabilities
According to the last reported balance sheet, Chasen Holdings had liabilities of S$59.6m due within 12 months, and liabilities of S$13.0m due beyond 12 months. On the other hand, it had cash of S$10.6m and S$62.0m worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
Having regard to Chasen Holdings’s size, it seems that its liquid assets are well balanced with its total liabilities. So while it’s hard to imagine that the S$27.9m company is struggling for cash, we still think it’s worth monitoring its balance sheet.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Chasen Holdings has net debt worth 1.7 times EBITDA, which isn’t too much, but its interest cover looks a bit on the low side, with EBIT at only 5.5 times the interest expense. While these numbers do not alarm us, it’s worth noting that the cost of the company’s debt is having a real impact. Also relevant is that Chasen Holdings has grown its EBIT by a very respectable 20% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chasen Holdings’s earnings that will influence how the balance sheet holds up in the future. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it’s worth checking how much of that EBIT is backed by free cash flow. In the last three years, Chasen Holdings created free cash flow amounting to 9.7% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
When it comes to the balance sheet, the standout positive for Chasen Holdings was the fact that it seems able to grow its EBIT confidently. However, our other observations weren’t so heartening. For example, its conversion of EBIT to free cash flow makes us a little nervous about its debt. Considering this range of data points, we think Chasen Holdings is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Given Chasen Holdings 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.
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.
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If you spot an error that warrants correction, please contact the editor at email@example.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.