SP Setia Berhad (KLSE:SPSETIA) takes some risk with its use of debt
Warren Buffett said: “Volatility is far from synonymous with risk. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies SP Setia Berhad (KLSE:SPSETIA) uses debt. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
See our latest analysis for SP Setia Berhad
What is SP Setia Berhad’s debt?
You can click on the graph below for historical figures, but it shows that in September 2021, SP Setia Berhad had debt of RM12.6 billion, an increase from RM11.5 billion, on a year. However, he has RM1.68 billion in cash to offset this, resulting in a net debt of around RM11.0 billion.
How strong is SP Setia Berhad’s balance sheet?
Zooming in on the latest balance sheet data, we can see that SP Setia Berhad had liabilities of RM4.94b due within 12 months and liabilities of RM10.8b due beyond. On the other hand, it had cash of RM1.68 billion and RM2.35 billion of receivables due within the year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of RM11.7 billion.
This deficit casts a shadow over RM5.37b society, like a colossus towering above mere mortals. We would therefore be watching his balance sheet closely, no doubt. Ultimately, SP Setia Berhad 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 ).
While SP Setia Berhad’s debt-to-EBITDA ratio of 20.5 suggests heavy leverage, its interest coverage of 9.1 implies it easily manages that debt. Overall, we’d say it seems likely that the company is carrying quite a heavy debt load. It should be noted that SP Setia Berhad’s EBIT jumped like bamboo after the rain, gaining 86% over the last twelve months. This will make it easier to manage your debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine SP Setia Berhad’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Fortunately for all shareholders, SP Setia Berhad has actually produced more free cash flow than EBIT over the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
We feel some trepidation about the difficulty level of SP Setia Berhad’s total passive, but we also have some positives to focus on. For example, its EBIT to free cash flow conversion and EBIT growth rate give us some confidence in its ability to manage its debt. We think SP Setia Berhad’s 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. Example: we have identified 1 warning sign for SP Setia Berhad you should be aware.
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.