Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Enviro-Hub Holdings Ltd. (SGX:L23) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Enviro-Hub Holdings's Net Debt?
As you can see below, Enviro-Hub Holdings had S$102.0m of debt, at June 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had S$4.14m in cash, and so its net debt is S$97.9m.
How Healthy Is Enviro-Hub Holdings's Balance Sheet?
The latest balance sheet data shows that Enviro-Hub Holdings had liabilities of S$14.2m due within a year, and liabilities of S$121.4m falling due after that. Offsetting this, it had S$4.14m in cash and S$9.41m in receivables that were due within 12 months. So it has liabilities totalling S$122.0m more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the S$36.2m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Enviro-Hub Holdings would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Enviro-Hub Holdings 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.
In the last year Enviro-Hub Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 4.2%, to S$33m. We usually like to see faster growth from unprofitable companies, but each to their own.
Importantly, Enviro-Hub Holdings had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at S$186.0k. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost S$611.0k in just last twelve months, and it doesn't have much by way of liquid assets. So while it's not wise to assume the company will fail, we do think it's risky. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Enviro-Hub Holdings (at least 1 which can't be ignored) , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. 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.
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