Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that SBS Transit Ltd (SGX:S61) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for SBS Transit
What Is SBS Transit's Net Debt?
As you can see below, SBS Transit had S$75.0m of debt at June 2020, down from S$101.0m a year prior. However, its balance sheet shows it holds S$94.5m in cash, so it actually has S$19.5m net cash.
How Healthy Is SBS Transit's Balance Sheet?
The latest balance sheet data shows that SBS Transit had liabilities of S$419.0m due within a year, and liabilities of S$181.4m falling due after that. Offsetting these obligations, it had cash of S$94.5m as well as receivables valued at S$218.4m due within 12 months. So its liabilities total S$287.5m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since SBS Transit has a market capitalization of S$969.9m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, SBS Transit boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact SBS Transit's saving grace is its low debt levels, because its EBIT has tanked 28% in the last twelve months. 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 it is future earnings, more than anything, that will determine SBS Transit'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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While SBS Transit 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, SBS Transit actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing up
While SBS Transit does have more liabilities than liquid assets, it also has net cash of S$19.5m. And it impressed us with free cash flow of S$165m, being 136% of its EBIT. So we are not troubled with SBS Transit's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in SBS Transit, you may well want to click here to check an interactive graph of its earnings per share history.
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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About SGX:S61
SBS Transit
Provides bus and rail public transport services primarily in Singapore.
Flawless balance sheet and fair value.
