Is Raffles Education (SGX:NR7) Weighed On By Its Debt Load?

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.' 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. As with many other companies Raffles Education Corporation Limited (SGX:NR7) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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What Is Raffles Education's Debt?

The image below, which you can click on for greater detail, shows that Raffles Education had debt of S$301.2m at the end of June 2022, a reduction from S$391.4m over a year. However, because it has a cash reserve of S$69.5m, its net debt is less, at about S$231.7m.

How Healthy Is Raffles Education's Balance Sheet?

The latest balance sheet data shows that Raffles Education had liabilities of S$275.3m due within a year, and liabilities of S$220.3m falling due after that. On the other hand, it had cash of S$69.5m and S$43.4m worth of receivables due within a year. So its liabilities total S$382.8m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the S$68.9m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Raffles Education would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Raffles Education 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.

In the last year Raffles Education wasn't profitable at an EBIT level, but managed to grow its revenue by 7.8%, to S$105m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Raffles Education produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable S$20m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through S$16m in the last year. So we think this stock is risky, like walking through a dirty dog park with a mask on. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Raffles Education 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.