Is Duty Free International (SGX:5SO) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Duty Free International Limited (SGX:5SO) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Duty Free International

What Is Duty Free International's Net Debt?

The image below, which you can click on for greater detail, shows that Duty Free International had debt of RM6.38m at the end of May 2021, a reduction from RM24.2m over a year. But on the other hand it also has RM219.0m in cash, leading to a RM212.6m net cash position.

A Look At Duty Free International's Liabilities

According to the last reported balance sheet, Duty Free International had liabilities of RM51.8m due within 12 months, and liabilities of RM96.1m due beyond 12 months. Offsetting these obligations, it had cash of RM219.0m as well as receivables valued at RM53.9m due within 12 months. So it can boast RM124.9m more liquid assets than total liabilities.

This luscious liquidity implies that Duty Free International's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Duty Free International boasts net cash, so it's fair to say it does not have a heavy debt load! 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 Duty Free International will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Duty Free International had a loss before interest and tax, and actually shrunk its revenue by 59%, to RM214m. To be frank that doesn't bode well.

So How Risky Is Duty Free International?

While Duty Free International lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow RM26m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Duty Free International (of which 1 makes us a bit uncomfortable!) you should know about.

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.

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.

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