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.’ 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, Sheng Siong Group Ltd (SGX:OV8) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Sheng Siong Group Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2020 Sheng Siong Group had S$30.0m of debt, an increase on none, over one year. But it also has S$252.2m in cash to offset that, meaning it has S$222.2m net cash.
How Healthy Is Sheng Siong Group’s Balance Sheet?
According to the last reported balance sheet, Sheng Siong Group had liabilities of S$266.2m due within 12 months, and liabilities of S$51.9m due beyond 12 months. Offsetting these obligations, it had cash of S$252.2m as well as receivables valued at S$13.9m due within 12 months. So its liabilities total S$52.0m more than the combination of its cash and short-term receivables.
Having regard to Sheng Siong Group’s size, it seems that its liquid assets are well balanced with its total liabilities. So it’s very unlikely that the S$2.77b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Sheng Siong Group also has more cash than debt, so we’re pretty confident it can manage its debt safely.
In addition to that, we’re happy to report that Sheng Siong Group has boosted its EBIT by 49%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sheng Siong Group’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Sheng Siong Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Sheng Siong Group actually produced more free cash flow than EBIT. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
We could understand if investors are concerned about Sheng Siong Group’s liabilities, but we can be reassured by the fact it has has net cash of S$222.2m. The cherry on top was that in converted 105% of that EBIT to free cash flow, bringing in S$193m. So we don’t think Sheng Siong Group’s use of debt is risky. 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. For example, we’ve discovered 2 warning signs for Sheng Siong Group (1 is significant!) that you should be aware of before investing here.
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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