Does Serial System (SGX:S69) Have A Healthy Balance Sheet?

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.' 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 can see that Serial System Ltd (SGX:S69) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Serial System

What Is Serial System's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Serial System had US$127.6m of debt in June 2020, down from US$147.9m, one year before. On the flip side, it has US$64.8m in cash leading to net debt of about US$62.8m.

A Look At Serial System's Liabilities

Zooming in on the latest balance sheet data, we can see that Serial System had liabilities of US$219.4m due within 12 months and liabilities of US$8.67m due beyond that. On the other hand, it had cash of US$64.8m and US$119.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$44.2m.

This is a mountain of leverage relative to its market capitalization of US$47.3m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Serial System 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.

Over 12 months, Serial System made a loss at the EBIT level, and saw its revenue drop to US$675m, which is a fall of 41%. To be frank that doesn't bode well.

Caveat Emptor

While Serial System's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable US$8.3m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of US$1.9m into a profit. In the meantime, we consider the stock very risky. 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. Be aware that Serial System is showing 3 warning signs in our investment analysis , and 2 of those don't sit too well with us...

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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