Advertisement
Australia markets closed
  • ALL ORDS

    8,153.70
    +80.10 (+0.99%)
     
  • ASX 200

    7,896.90
    +77.30 (+0.99%)
     
  • AUD/USD

    0.6515
    -0.0003 (-0.05%)
     
  • OIL

    83.11
    -0.06 (-0.07%)
     
  • GOLD

    2,254.80
    +16.40 (+0.73%)
     
  • Bitcoin AUD

    107,288.65
    -1,233.53 (-1.14%)
     
  • CMC Crypto 200

    885.54
    0.00 (0.00%)
     
  • AUD/EUR

    0.6043
    +0.0009 (+0.15%)
     
  • AUD/NZD

    1.0904
    +0.0002 (+0.02%)
     
  • NZX 50

    12,105.29
    +94.63 (+0.79%)
     
  • NASDAQ

    18,254.69
    -26.15 (-0.14%)
     
  • FTSE

    7,952.62
    +20.64 (+0.26%)
     
  • Dow Jones

    39,807.37
    +47.29 (+0.12%)
     
  • DAX

    18,492.49
    +15.40 (+0.08%)
     
  • Hang Seng

    16,541.42
    +148.58 (+0.91%)
     
  • NIKKEI 225

    40,369.44
    +201.37 (+0.50%)
     

These 4 Measures Indicate That Speedcast International (ASX:SDA) Is Using Debt Extensively

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Speedcast International Limited (ASX:SDA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

ADVERTISEMENT

View our latest analysis for Speedcast International

What Is Speedcast International's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2018 Speedcast International had US$639.4m of debt, an increase on US$432.2m, over one year. However, because it has a cash reserve of US$100.0m, its net debt is less, at about US$539.3m.

ASX:SDA Historical Debt, August 1st 2019
ASX:SDA Historical Debt, August 1st 2019

A Look At Speedcast International's Liabilities

According to the last reported balance sheet, Speedcast International had liabilities of US$262.3m due within 12 months, and liabilities of US$676.0m due beyond 12 months. Offsetting these obligations, it had cash of US$100.0m as well as receivables valued at US$216.6m due within 12 months. So its liabilities total US$621.6m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the US$321.1m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Speedcast International would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Speedcast International's debt to EBITDA ratio (4.1) suggests that it uses some debt, its interest cover is very weak, at 1.4, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Fortunately, Speedcast International grew its EBIT by 3.0% in the last year, slowly shrinking its debt relative to earnings. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Speedcast International can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Speedcast International produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

To be frank both Speedcast International's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We're quite clear that we consider Speedcast International to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.