Here's Why MindChamps PreSchool (SGX:CNE) Has A Meaningful Debt Burden

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 MindChamps PreSchool Limited (SGX:CNE) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for MindChamps PreSchool

What Is MindChamps PreSchool's Net Debt?

As you can see below, MindChamps PreSchool had S$16.3m of debt at June 2023, down from S$31.3m a year prior. However, because it has a cash reserve of S$4.24m, its net debt is less, at about S$12.1m.

A Look At MindChamps PreSchool's Liabilities

The latest balance sheet data shows that MindChamps PreSchool had liabilities of S$43.5m due within a year, and liabilities of S$24.5m falling due after that. On the other hand, it had cash of S$4.24m and S$31.1m worth of receivables due within a year. So it has liabilities totalling S$32.7m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since MindChamps PreSchool has a market capitalization of S$64.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.24 times and a disturbingly high net debt to EBITDA ratio of 51.5 hit our confidence in MindChamps PreSchool like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. One redeeming factor for MindChamps PreSchool is that it turned last year's EBIT loss into a gain of S$553k, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is MindChamps PreSchool'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, MindChamps PreSchool actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Neither MindChamps PreSchool's ability to cover its interest expense with its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Looking at all the angles mentioned above, it does seem to us that MindChamps PreSchool is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. 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 4 warning signs for MindChamps PreSchool (of which 2 are a bit concerning!) you should know about.

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.