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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 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 is this debt a concern to shareholders?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for SBS Transit
How Much Debt Does SBS Transit Carry?
As you can see below, SBS Transit had S$101.0m of debt at June 2019, down from S$156.5m a year prior. On the flip side, it has S$7.59m in cash leading to net debt of about S$93.4m.
A Look At SBS Transit's Liabilities
The latest balance sheet data shows that SBS Transit had liabilities of S$339.7m due within a year, and liabilities of S$270.8m falling due after that. Offsetting these obligations, it had cash of S$7.59m as well as receivables valued at S$215.7m due within 12 months. So its liabilities total S$387.2m more than the combination of its cash and short-term receivables.
SBS Transit has a market capitalization of S$1.28b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
SBS Transit's net debt is only 0.45 times its EBITDA. And its EBIT covers its interest expense a whopping 32.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, SBS Transit grew its EBIT by 47% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is SBS Transit's earnings that will influence how the balance sheet holds up in the future. 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.