Stock Analysis

Singapore Shipping (SGX:S19) Seems To Use Debt Quite Sensibly

SGX:S19
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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 note that Singapore Shipping Corporation Limited (SGX:S19) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Singapore Shipping

What Is Singapore Shipping's Debt?

The image below, which you can click on for greater detail, shows that Singapore Shipping had debt of US$53.4m at the end of September 2020, a reduction from US$58.4m over a year. However, it also had US$35.5m in cash, and so its net debt is US$17.9m.

debt-equity-history-analysis
SGX:S19 Debt to Equity History January 2nd 2021

A Look At Singapore Shipping's Liabilities

The latest balance sheet data shows that Singapore Shipping had liabilities of US$14.9m due within a year, and liabilities of US$68.0m falling due after that. On the other hand, it had cash of US$35.5m and US$3.35m worth of receivables due within a year. So it has liabilities totalling US$44.0m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Singapore Shipping has a market capitalization of US$75.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Singapore Shipping has a low net debt to EBITDA ratio of only 0.98. And its EBIT easily covers its interest expense, being 10.7 times the size. So we're pretty relaxed about its super-conservative use of debt. The good news is that Singapore Shipping has increased its EBIT by 6.0% over twelve months, which should ease any concerns about debt repayment. 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 Singapore Shipping 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Singapore Shipping 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.

Our View

The good news is that Singapore Shipping's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. All these things considered, it appears that Singapore Shipping can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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 Singapore Shipping .

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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