Is Straco (SGX:S85) A Risky Investment?

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 note that Straco Corporation Limited (SGX:S85) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Straco

What Is Straco's Net Debt?

As you can see below, Straco had S$8.60m of debt at December 2021, down from S$22.9m a year prior. But it also has S$178.6m in cash to offset that, meaning it has S$170.0m net cash.

How Healthy Is Straco's Balance Sheet?

The latest balance sheet data shows that Straco had liabilities of S$14.6m due within a year, and liabilities of S$73.0m falling due after that. Offsetting this, it had S$178.6m in cash and S$6.20m in receivables that were due within 12 months. So it actually has S$97.2m more liquid assets than total liabilities.

It's good to see that Straco has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Straco boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Straco made a loss at the EBIT level, last year, it was also good to see that it generated S$1.4m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Straco's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Straco 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 year, Straco 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 we empathize with investors who find debt concerning, you should keep in mind that Straco has net cash of S$170.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of S$16m, being 1,119% of its EBIT. So we don't think Straco's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Straco has 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.