Health Check: How Prudently Does Sebata Holdings (JSE:SEB) Use Debt?

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 Sebata Holdings Limited (JSE:SEB) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Sebata Holdings

What Is Sebata Holdings's Net Debt?

As you can see below, at the end of September 2021, Sebata Holdings had R40.0m of debt, up from R37.8m a year ago. Click the image for more detail. However, its balance sheet shows it holds R835.2m in cash, so it actually has R795.2m net cash.

How Strong Is Sebata Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sebata Holdings had liabilities of R62.9m due within 12 months and liabilities of R194.6m due beyond that. Offsetting this, it had R835.2m in cash and R11.9m in receivables that were due within 12 months. So it can boast R589.6m more liquid assets than total liabilities.

This excess liquidity is a great indication that Sebata Holdings' balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Sebata Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Sebata Holdings 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, Sebata Holdings made a loss at the EBIT level, and saw its revenue drop to R25m, which is a fall of 79%. That makes us nervous, to say the least.

So How Risky Is Sebata Holdings?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Sebata Holdings had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through R26m of cash and made a loss of R224m. With only R795.2m on the balance sheet, it would appear that its going to need to raise capital again soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Sebata Holdings is showing 3 warning signs in our investment analysis , and 1 of those is significant...

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.