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 Telechoice International Limited (SGX:T41) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Telechoice International's Debt?
You can click the graphic below for the historical numbers, but it shows that Telechoice International had S$14.1m of debt in December 2020, down from S$22.2m, one year before. However, it does have S$27.3m in cash offsetting this, leading to net cash of S$13.2m.
A Look At Telechoice International's Liabilities
We can see from the most recent balance sheet that Telechoice International had liabilities of S$51.2m falling due within a year, and liabilities of S$4.43m due beyond that. Offsetting these obligations, it had cash of S$27.3m as well as receivables valued at S$64.2m due within 12 months. So it can boast S$35.9m more liquid assets than total liabilities.
This luscious liquidity implies that Telechoice International's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Telechoice International has more cash than debt is arguably a good indication that it can manage its debt safely.
Shareholders should be aware that Telechoice International's EBIT was down 80% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Telechoice 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Telechoice International may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Telechoice International actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to investigate a company's debt, in this case Telechoice International has S$13.2m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 103% of that EBIT to free cash flow, bringing in S$23m. So we are not troubled with Telechoice International's debt use. 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 Telechoice International you should be aware of, and 1 of them is a bit concerning.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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