MindChamps PreSchool (SGX:CNE) Has Debt But No Earnings; Should You Worry?

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.' 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. 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?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Our analysis indicates that CNE is potentially undervalued!

How Much Debt Does MindChamps PreSchool Carry?

As you can see below, MindChamps PreSchool had S$31.3m of debt at June 2022, down from S$38.4m a year prior. However, because it has a cash reserve of S$10.2m, its net debt is less, at about S$21.1m.

How Strong Is MindChamps PreSchool's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that MindChamps PreSchool had liabilities of S$41.9m due within 12 months and liabilities of S$41.0m due beyond that. Offsetting these obligations, it had cash of S$10.2m as well as receivables valued at S$24.9m due within 12 months. So its liabilities total S$47.8m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of S$46.4m, we think shareholders really should watch MindChamps PreSchool's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since MindChamps PreSchool will need earnings to service that debt. 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.

Over 12 months, MindChamps PreSchool reported revenue of S$63m, which is a gain of 3.4%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, MindChamps PreSchool had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at S$1.8m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. But on the bright side the company actually produced a statutory profit of S$3.7m and free cash flow of S$9.5m. So there is definitely a chance that it can improve things in the next few years. 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. For example MindChamps PreSchool has 3 warning signs (and 1 which can't be ignored) we think you should know about.

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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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.