A company’s balance sheet gives investors clues on its financial stability. When balance sheets become bloated with debt, it gets riskier for investors. One of the sure-fire ways for investors to lose money is for the companies they’re invested in to undergo bankruptcy when debts can’t be repaid. Bondholders or other creditors will get first claims to a bankrupt-company’s assets, leaving at best scraps, or at worst nothing for shareholders. Now, debt’s not inherently bad. But it always creates additional financial risks when it’s present in large quantities. That’s why it’s important for shareholders to keep a look-out for…
A company’s balance sheet gives investors clues on its financial stability. When balance sheets become bloated with debt, it gets riskier for investors. One of the sure-fire ways for investors to lose money is for the companies they’re invested in to undergo bankruptcy when debts can’t be repaid.
Bondholders or other creditors will get first claims to a bankrupt-company’s assets, leaving at best scraps, or at worst nothing for shareholders.
Now, debt’s not inherently bad. But it always creates additional financial risks when it’s present in large quantities. That’s why it’s important for shareholders to keep a look-out for the level of debt found on a company’s balance sheet. And, to err on the side of caution, we’ll ideally like to see more cash than debt.
Sometimes, companies inevitably have to borrow money because the cash that’s generated from their daily operations aren’t enough to fund their growth needs. But in the pursuit of debt-fuelled growth, they create additional worries for investors.
In the past few years since the Great Financial Crisis of 2007/2009, interest rates have been kept at historic lows, making it very cheap to borrow money. And, companies weren’t shy in doing so, as evidenced by a record amount of corporate-bond sales last year. But, the era of low interest rates might be ending soon with recent comments made by US Federal Reserve Chairman Ben Bernanke hinting at the possibility of a slow-down in the Fed’s asset purchases in the later part of this year.
Companies that have borrowed excessively might find themselves under pressure when the costs of borrowing start heading north. Indeed, heavily levered real estate investment trusts have seen prices collapsing, with the FTSE Straits Times REIT Index (SGX: FSTAS8670) dropping 20% as of 13 Sep 2013 since the start of May. That’s almost thrice the broad market’s fall, represented by the Straits Times Index’s (SGX: ^STI) 7.4% decline.
So, this lends pertinence to the issue of companies with strong balance sheets who might find themselves unfazed by interest rate hikes because they eschewed debt even when it was cheap to borrow.
These are companies that have been funding their growth or daily business activities primarily through organic cash generation without the need for leverage, putting the minds of their shareholders at greater ease without the worries of excessive leverage. Let’s take a look at three such companies.
1. Super Group (SGX: S10) – Price: $4.44, Price-Earnings Ratio (PE): 24.2, Dividend Yield: 1.6%
The instant beverage manufacturer carried trivial amounts of debt on its balance sheet in 2008 and has since eliminated all debt as shown in the graph below. Along the way, the company has grown its profits by 308% from S$25m in 2008 to S$102m in the last 12 months and increased its cash hoard on the balance sheet from S$29m to S$98m.
Super Group’s growth has been propelled by its Food Ingredient Sales division, where it sells dairy creamers, freeze-dried coffee and spray-dried coffee to other beverage manufacturers. The division brought in S$31.2m in revenue for the whole of 2009, but has since ballooned to S$164m in 2012 and S$46m in the second quarter of 2013 alone
The company has a Botanical Herbal Extracts (BHE) production plant in the works that’s slated to start operations by the end of this year. Funding for the plant’s being provided by the company’s prodigious operating cash flows, negating the need for debt. BHEs will add a whole new line of products to Super Group’s Food Ingredients Sales division, which management hopes will be fuel for the next phase of growth.
2. Raffles Medical Group (SGX: R01) – Price: $3.09, PE: 27.9, Dividend Yield: 1.5%
Health-care providers are said to be defensive businesses which can thrive in both benign and hostile economic climates. And, it seems that RMG fits the bill to a tee as its revenue and earnings grew by a total of 50% and 100% from 2006 to 2008 as the Great Financial Crisis of 2007-2009 couldn’t seem to dent the company’s rocket-like performance-trajectory.
RMG has gone from strength-to-strength since, as earnings increased by 92% from S$32m in 2008 to S$61m in the past 12 months. It has also managed to do so with a balance sheet that carried on average, more than twice the amount of debt in cash, as can be inferred from the graph below.
In recent news, the company announced plans to co-develop an integrated international hospital in Shanghai, China (subject to finalisation of terms and regulatory approval) with Shanghai Binjiang International Tourism Development Co. Ltd. The hospital will contain more than 300 beds and aims to provide high-end medical services.
3. Vicom (SGX: V01) – Price: $4.77, PE: 15.4, Dividend Yield: 3.8%
There’s an old Chinese idiom that says ‘good things comes in pairs’ (好事成双). And for Vicom, that pair appears in the form of growing profits and a growing cash hoard. The company’s profits have increased every year since at least 2008, and it earned S$27m in the last 12 months, 73% higher than 2008’s profit of S$16m. Meanwhile, Vicom’s debt-free balance sheet grows stronger each year with an increasing pile of cash, as depicted in the graph below.
Drivers in Singapore are required to send their vehicles for annual inspections and Vicom runs seven out of nine such vehicle-inspection centres around the island.
Despite the company’s dominance in vehicle inspection services, they are far from a one-trick pony. Vicom runs commercial testing and inspection operations under the SETSCO banner and that made up 66% of the company’s revenues in 2011.
SETSCO’s corporate performance has been exemplary, with revenue growing at 11.4% per year for the decade ending 2012, and operating profits increasing at an even faster clip of 25.3% annually.
We praised Vicom’s cash balance earlier, but companies can sometimes be doing shareholders a disservice by hoarding un-needed cash instead of returning it in the form of dividends. On that front, Vicom has certainly not disappointed their investors as dividends have grown from 9.25 Singapore cents in 2008 to 18.2 Singapore cents in 2012.
A strong balance sheet helps put a company in a position of lesser risk and in times of economic turmoil, can be a fortress of stability. While it’s important to focus on growing profits and cash flows, it also pays for investors to keep an eye on companies’ balance sheets.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing owns shares in Super Group and Raffles Medical Group.