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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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies BH Global Corporation Limited (SGX:BQN) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 BH Global
What Is BH Global's Debt?
As you can see below, BH Global had S$18.0m of debt at June 2019, down from S$20.7m a year prior. On the flip side, it has S$5.86m in cash leading to net debt of about S$12.1m.
A Look At BH Global's Liabilities
Zooming in on the latest balance sheet data, we can see that BH Global had liabilities of S$24.3m due within 12 months and liabilities of S$12.4m due beyond that. On the other hand, it had cash of S$5.86m and S$16.4m worth of receivables due within a year. So it has liabilities totalling S$14.5m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of S$22.5m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
BH Global's debt is 3.9 times its EBITDA, and its EBIT cover its interest expense 2.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, the silver lining was that BH Global achieved a positive EBIT of S$2.1m in the last twelve months, an improvement on the prior year's loss. 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 BH Global will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.