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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, MindChamps PreSchool Limited (SGX:CNE) does carry debt. But is this debt a concern to shareholders?
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. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is MindChamps PreSchool's Net Debt?
As you can see below, MindChamps PreSchool had S$39.2m of debt at December 2020, down from S$41.3m a year prior. However, it does have S$11.3m in cash offsetting this, leading to net debt of about S$27.8m.
How Healthy Is MindChamps PreSchool's Balance Sheet?
The latest balance sheet data shows that MindChamps PreSchool had liabilities of S$32.4m due within a year, and liabilities of S$55.5m falling due after that. On the other hand, it had cash of S$11.3m and S$17.2m worth of receivables due within a year. So it has liabilities totalling S$59.4m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of S$76.1m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, MindChamps PreSchool made a loss at the EBIT level, and saw its revenue drop to S$52m, which is a fall of 3.9%. That's not what we would hope to see.
Over the last twelve months MindChamps PreSchool produced an earnings before interest and tax (EBIT) loss. Indeed, it lost S$7.2m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much 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$11m and a profit of S$3.2m. So one might argue that there's still a chance it can get things on the right track. 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 3 warning signs for MindChamps PreSchool that you should be aware of before investing here.
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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