Does Low Keng Huat (Singapore) (SGX:F1E) Have A Healthy Balance Sheet?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Low Keng Huat (Singapore) Limited (SGX:F1E) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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.

Check out our latest analysis for Low Keng Huat (Singapore)

What Is Low Keng Huat (Singapore)'s Net Debt?

As you can see below, Low Keng Huat (Singapore) had S$575.5m of debt at July 2023, down from S$629.2m a year prior. However, it also had S$98.2m in cash, and so its net debt is S$477.3m.

How Healthy Is Low Keng Huat (Singapore)'s Balance Sheet?

We can see from the most recent balance sheet that Low Keng Huat (Singapore) had liabilities of S$53.3m falling due within a year, and liabilities of S$575.5m due beyond that. Offsetting these obligations, it had cash of S$98.2m as well as receivables valued at S$55.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$474.9m.

The deficiency here weighs heavily on the S$243.8m 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 definitely think shareholders need to watch this one closely. After all, Low Keng Huat (Singapore) would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Low Keng Huat (Singapore) shareholders face the double whammy of a high net debt to EBITDA ratio (14.7), and fairly weak interest coverage, since EBIT is just 0.87 times the interest expense. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that Low Keng Huat (Singapore) actually grew its EBIT by a hefty 379%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Low Keng Huat (Singapore) 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Low Keng Huat (Singapore) actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

To be frank both Low Keng Huat (Singapore)'s interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Low Keng Huat (Singapore) stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Low Keng Huat (Singapore) you should be aware of, and 2 of them make us uncomfortable.

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.