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.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Renaissance United Limited (SGX:I11) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Renaissance United
What Is Renaissance United’s Debt?
The chart below, which you can click on for greater detail, shows that Renaissance United had S$20.3m in debt in April 2019; about the same as the year before. However, because it has a cash reserve of S$9.15m, its net debt is less, at about S$11.1m.
How Strong Is Renaissance United’s Balance Sheet?
The latest balance sheet data shows that Renaissance United had liabilities of S$50.9m due within a year, and liabilities of S$6.57m falling due after that. On the other hand, it had cash of S$9.15m and S$11.2m worth of receivables due within a year. So its liabilities total S$37.0m more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the S$6.18m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Renaissance United would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Renaissance United’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Renaissance United managed to grow its revenue by 7.1%, to S$63m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Caveat Emptor
Importantly, Renaissance United had negative earnings before interest and tax (EBIT), over the last year. Its EBIT loss was a whopping S$1.5m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it lost S$34m in just last twelve months, and it doesn’t have much by way of liquid assets. So while it will probably survive, we think it’s risky; we’d treat it like chicken pox and try to avoid it. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Renaissance United insider transactions.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.