We Think Frasers Property (SGX:TQ5) Is Taking Some Risk With Its Debt

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.' 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. We note that Frasers Property Limited (SGX:TQ5) does have debt on its balance sheet. 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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Frasers Property

How Much Debt Does Frasers Property Carry?

The image below, which you can click on for greater detail, shows that Frasers Property had debt of S$17.9b at the end of September 2021, a reduction from S$20.0b over a year. However, it does have S$3.78b in cash offsetting this, leading to net debt of about S$14.1b.

A Look At Frasers Property's Liabilities

Zooming in on the latest balance sheet data, we can see that Frasers Property had liabilities of S$7.27b due within 12 months and liabilities of S$14.7b due beyond that. Offsetting this, it had S$3.78b in cash and S$552.6m in receivables that were due within 12 months. So it has liabilities totalling S$17.6b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the S$4.24b 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. At the end of the day, Frasers Property 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 11.2, it's fair to say Frasers Property does have a significant amount of debt. However, its interest coverage of 3.1 is reasonably strong, which is a good sign. On a lighter note, we note that Frasers Property grew its EBIT by 22% in the last year. If sustained, this growth should make that debt evaporate like a scarce drinking water during an unnaturally hot summer. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Frasers Property can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Frasers Property generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

To be frank both Frasers Property's net debt to EBITDA 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. Once we consider all the factors above, together, it seems to us that Frasers Property's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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 4 warning signs for Frasers Property you should be aware of, and 2 of them are concerning.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.