David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that Space Group Holdings Limited (HKG:2448) uses debt in his business. But the more important question is: what risk does this debt create?
What risk does debt carry?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
Check out our latest analysis for Space Group Holdings
What is Space Group Holdings net debt?
The image below, which you can click for more details, shows that as of December 2021, Space Group Holdings had debt of $499.3 million MO, up from $436.9 million MO in one year . However, he has MO$98.5 million in cash to offset this, resulting in a net debt of around MO$400.8 million.
How strong is Space Group Holdings’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Space Group Holdings had liabilities of MO$639.1 million due within 12 months and liabilities of MO$19.0 million due beyond. In return, he had MO$98.5 million in cash and MO$455.5 million in receivables due within 12 months. It therefore has liabilities totaling MB104.1 million more than its cash and short-term receivables, combined.
Of course, Space Group Holdings has a market capitalization of MB$3.01 billion, so those liabilities are probably manageable. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
With a net debt to EBITDA ratio of 5.2, it’s fair to say that Space Group Holdings has significant debt. However, its interest coverage of 4.7 is reasonably strong, which is a good sign. Above all, Space Group Holdings has increased its EBIT by 39% over the last twelve months, and this growth will make it easier to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of Space Group Holdings that will influence the balance sheet in the future. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.
Finally, a company can only repay its debts with cold hard cash, not with book profits. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Space Group Holdings has burned through a lot of cash. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.
Our point of view
We weren’t impressed with Space Group Holdings’ net debt to EBITDA ratio, and its EBIT to free cash flow conversion made us cautious. But like a ballerina who finishes on a perfect pirouette, she has no trouble growing her EBIT. When we consider all of the factors mentioned above, we feel a bit cautious about Space Group Holdings’ use of debt. While we understand that debt can improve returns on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. We have identified 4 warning signs with Space Group Holdings (at least 3 of which are a little nasty), and understanding them should be part of your investment process.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.