We Think Sheng Siong Group (SGX:OV8) Can Manage Its Debt With Ease

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.' 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, Sheng Siong Group Ltd (SGX:OV8) does carry debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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, 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.

Check out our latest analysis for Sheng Siong Group

What Is Sheng Siong Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Sheng Siong Group had S$30.0m of debt, an increase on none, over one year. But it also has S$253.9m in cash to offset that, meaning it has S$223.9m net cash.

How Healthy Is Sheng Siong Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sheng Siong Group had liabilities of S$275.2m due within 12 months and liabilities of S$41.7m due beyond that. Offsetting these obligations, it had cash of S$253.9m as well as receivables valued at S$19.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$43.1m.

This state of affairs indicates that Sheng Siong Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the S$2.35b company is struggling for cash, we still think it's worth monitoring its 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.

On top of that, Sheng Siong Group grew its EBIT by 78% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Sheng Siong Group has S$223.9m in net cash. The cherry on top was that in converted 113% of that EBIT to free cash flow, bringing in S$257m. So is Sheng Siong Group's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Sheng Siong Group (including 1 which is significant) .

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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