Chasen Holdings (SGX: 5NV) has a somewhat stretched balance sheet
Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to consider debt when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Chasen Holdings Limited (SGX:5NV) is in debt. But the more important question is: what risk does this debt create?
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for Chasen Holdings
What is Chasen Holdings’ net debt?
The image below, which you can click on for more details, shows that in March 2022, Chasen Holdings had a debt of S$64.8 million, up from S$57.8 million in one year. However, he also had S$19.1 million in cash, so his net debt is S$45.7 million.
A look at the liabilities of Chasen Holdings
The latest balance sheet data shows that Chasen Holdings had liabilities of S$78.6 million due within one year, and liabilities of S$38.9 million falling due thereafter. On the other hand, it had cash of S$19.1 million and S$57.1 million of receivables due within one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of S$41.4 million.
This deficit casts a shadow over the 24.4 million Singaporean company, like a colossus towering above mere mortals. We would therefore watch his balance sheet closely, no doubt. Ultimately, Chasen Holdings would likely need a major recapitalization if its creditors were to demand repayment.
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 ).
Chasen Holdings has a debt to EBITDA ratio of 3.7 and its EBIT covered its interest expense 3.0 times. This suggests that while debt levels are significant, we will refrain from labeling them as problematic. On the bright side, Chasen Holdings has grown its EBIT by 82% over the past year. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of managing debt. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since Chasen Holdings will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Finally, while the taxman may love accounting profits, lenders only accept cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past two years, Chasen Holdings has generated free cash flow of a very strong 92% of its EBIT, more than expected. This puts him in a very strong position to repay his debt.
Our point of view
We feel some trepidation about the difficulty level of Chasen Holdings’ total liabilities, but we also have some positives to focus on. The EBIT to free cash flow conversion and the EBIT growth rate were encouraging signs. We think Chasen Holdings’ debt makes it a bit risky, after looking at the aforementioned data points together. Not all risk is bad, as it can increase stock price returns if it pays off, but this leverage risk is worth keeping in mind. 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. For example, we have identified 4 warning signs for Chasen Holdings (2 are potentially serious) of which you should be aware.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.
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