Is Southern Archipelago (SGX:A33) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Southern Archipelago Ltd. (SGX:A33) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Southern Archipelago

What Is Southern Archipelago's Net Debt?

The image below, which you can click on for greater detail, shows that Southern Archipelago had debt of S$4.35m at the end of June 2023, a reduction from S$7.84m over a year. On the flip side, it has S$3.62m in cash leading to net debt of about S$732.0k.

How Healthy Is Southern Archipelago's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Southern Archipelago had liabilities of S$4.12m due within 12 months and liabilities of S$2.09m due beyond that. Offsetting these obligations, it had cash of S$3.62m as well as receivables valued at S$458.0k due within 12 months. So it has liabilities totalling S$2.13m more than its cash and near-term receivables, combined.

Of course, Southern Archipelago has a market capitalization of S$55.1m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Southern Archipelago has virtually no net debt, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Southern Archipelago will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Southern Archipelago reported revenue of S$5.5m, which is a gain of 29%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Even though Southern Archipelago managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost S$510k at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Surprisingly, we note that it actually reported positive free cash flow of S$515k and a profit of S$664k. So one might argue that there's still a chance it can get things on the right track. 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. Be aware that Southern Archipelago is showing 4 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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.