Is Silverlake Axis (SGX:5CP) 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.' 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 Silverlake Axis Ltd (SGX:5CP) does use debt in its business. But the more important question is: how much risk is that debt creating?

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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Silverlake Axis

What Is Silverlake Axis's Net Debt?

The image below, which you can click on for greater detail, shows that Silverlake Axis had debt of RM76.4m at the end of December 2020, a reduction from RM101.4m over a year. However, its balance sheet shows it holds RM770.8m in cash, so it actually has RM694.4m net cash.

A Look At Silverlake Axis' Liabilities

According to the last reported balance sheet, Silverlake Axis had liabilities of RM324.9m due within 12 months, and liabilities of RM172.3m due beyond 12 months. Offsetting this, it had RM770.8m in cash and RM183.7m in receivables that were due within 12 months. So it actually has RM457.3m more liquid assets than total liabilities.

This surplus suggests that Silverlake Axis is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Silverlake Axis has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Silverlake Axis if management cannot prevent a repeat of the 27% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Silverlake Axis can strengthen its balance sheet over time. 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. While Silverlake Axis has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Silverlake Axis recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Silverlake Axis has RM694.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of RM166m, being 85% of its EBIT. So is Silverlake Axis's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Silverlake Axis .

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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This article by Simply Wall St is general in nature. 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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