GuocoLand (SGX:F17) Seems To Be Using A Lot Of Debt

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.' 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. We note that GuocoLand Limited (SGX:F17) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

See our latest analysis for GuocoLand

How Much Debt Does GuocoLand Carry?

The chart below, which you can click on for greater detail, shows that GuocoLand had S$5.92b in debt in December 2020; about the same as the year before. However, it does have S$998.3m in cash offsetting this, leading to net debt of about S$4.92b.

How Strong Is GuocoLand's Balance Sheet?

The latest balance sheet data shows that GuocoLand had liabilities of S$1.15b due within a year, and liabilities of S$5.18b falling due after that. Offsetting this, it had S$998.3m in cash and S$122.1m in receivables that were due within 12 months. So its liabilities total S$5.21b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the S$1.84b 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. At the end of the day, GuocoLand would probably need a major re-capitalization if its creditors were to demand repayment.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.7 times and a disturbingly high net debt to EBITDA ratio of 31.9 hit our confidence in GuocoLand like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, GuocoLand saw its EBIT tank 50% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine GuocoLand's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, GuocoLand reported free cash flow worth 19% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

To be frank both GuocoLand's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. We think the chances that GuocoLand has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for GuocoLand (of which 2 are a bit concerning!) 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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