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. We can see that CSE Global Limited (SGX:544) does use debt in its business. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for CSE Global
What Is CSE Global's Net Debt?
As you can see below, CSE Global had S$91.5m of debt at December 2020, down from S$103.1m a year prior. However, it also had S$52.5m in cash, and so its net debt is S$39.0m.
A Look At CSE Global's Liabilities
The latest balance sheet data shows that CSE Global had liabilities of S$161.1m due within a year, and liabilities of S$49.1m falling due after that. On the other hand, it had cash of S$52.5m and S$170.3m worth of receivables due within a year. So it can boast S$12.6m more liquid assets than total liabilities.
This surplus suggests that CSE Global has a conservative balance sheet, and could probably eliminate its debt without much difficulty.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
CSE Global has a low net debt to EBITDA ratio of only 0.78. And its EBIT easily covers its interest expense, being 10.6 times the size. So we're pretty relaxed about its super-conservative use of debt. Also good is that CSE Global grew its EBIT at 19% over the last year, further increasing its ability to manage 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 CSE Global's ability to maintain a healthy balance sheet going forward. 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, CSE Global recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Our View
CSE Global's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Considering this range of factors, it seems to us that CSE Global is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for CSE Global you should be aware of, and 1 of them makes us a bit uncomfortable.
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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About SGX:544
CSE Global
An investment holding company, engages in the provision of integrated industrial automation, information technology, and intelligent transport solutions in the Asia Pacific, the Americas, Europe, the Middle East, and Africa.
Very undervalued with excellent balance sheet and pays a dividend.
