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Can This Company Sustain Its High Growth?

One of the fastest growing companies for the past few years has been Ezion Holdings Ltd (SGX: 5ME). Ezion is one of the leaders in developing, owning and chartering offshore vessels to the oil and gas industry. The company grew its net income by 58% annually for the past 3 years and it looks set to increase its profit again this year. Can Ezion continue to grow at such fast pace?

Three Levels Of Growth

In order for a company to grow, it has to continuously reinvest in its business. In order to do that, the company has three possible channels of funds to fuel the growth.

Basically a company can reinvest in its business by:

1)      Reinvesting internal generated cash flow

2)      Taking on debt

3)      Issuing new equity

Growing through its internal generated cash flow is most desired as it is assumed to be the most sustainable. Not all companies are able to do that, especially in industries where the initial capital outlay is huge.

And so, many companies choose to grow by taking on debt. This type of reinvestment is still acceptable, if leverage is not used excessively. As discussed before, leverage can be a double-edged sword. If it is not used prudently, the company might face liquidity or even bankruptcy risk when the business stops growing.

Lastly, some companies might choose to grow by issuing more equity. This is the least desirable type of financing as it dilutes existing shareholders equity. It is considered to be the highest cost of capital for a company.

Ezion Holdings has chosen to use debt as the main source of funding for its growth. Its long term debt increased from USD60 million in 2010 to USD1,112.8 million as at 30th June 2014. That is a growth of 130% annually for the past 3 years, a rather overwhelming increase.

The risk now is that the company would need to be able to sustain its growth so that its cash flow is able to meet its financial debt obligations in the future. Furthermore, as we move out from a low interest rate environment, the company would need to prepare itself for a much higher interest cost from its debt financing. If the company is not able to meet these challenges, there could be huge risks awaiting in its future.

Foolish Summary

For now, Ezion Holdings continued to be one of the fastest growing companies in its sector. However, the company has fueled this growth mainly through the use of debt, which can be a double edged sword. Whether the use of leverage will come back and haunt the company in the future is yet to be seen, but investors should know that such a risk is possible.

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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 Stanley Lim does not own any companies mentioned.