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 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. We can see that MindChamps PreSchool Limited (SGX:CNE) uses debt in its business. But the more important question is: what risk does this debt create?
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, many companies use debt to finance their growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest review for MindChamps PreSchool
What is MindChamps PreSchool’s debt?
As you can see below, MindChamps PreSchool had a debt of S$37.6 million as of December 2021, compared to S$39.2 million the previous year. On the other hand, he has S$11.0 million in cash, resulting in a net debt of around S$26.6 million.
How healthy is MindChamps PreSchool’s track record?
We can see from the most recent balance sheet that MindChamps PreSchool had liabilities of S$36.5 million maturing within one year, and liabilities of S$46.0 million beyond that. On the other hand, it had cash of S$11.0 million and S$18.1 million of receivables due within one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of S$53.4 million.
This is a mountain of leverage compared to its market capitalization of S$54.4 million. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly. There is no doubt that we learn the most about debt from the balance sheet. But it is the revenues of MindChamps PreSchool that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Over 12 months, MindChamps PreSchool reported revenue of S$63 million, a gain of 21%, although it reported no earnings before interest and tax. The shareholders probably have their fingers crossed that she can make a profit.
While we can certainly appreciate MindChamps PreSchool’s revenue growth, its earnings before interest and tax (EBIT) loss is less than ideal. To be precise, the EBIT loss amounted to S$1.1 million. Considering that alongside the liabilities mentioned above, this doesn’t give us much confidence that the company should use so much debt. So we think its balance sheet is a little stretched, but not beyond repair. On the positive side, we note that last twelve months EBIT is worse than free cash flow of S$11 million and profit of S$2.4 million. So you could say that there is still a chance that this could put things on the right track. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 4 warning signs with MindChamps PreSchool (at least 1 which is a little nasty), and understanding them should be part of your investment process.
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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