Is Starhub Ltd Overleveraged?

Leverage is a double-edged sword – it can magnify your profits during good times but it can also destroy you during bad times.

Yet, a company such as telecommunications outfit Starhub Ltd (SGX: CC3), typically considered as a safe and stable blue-chip share, has an extremely high net-debt to equity ratio of 443% as of the end of June 2014. Does Starhub deserve its label as a stable blue-chip, or is it actually an over-leveraged ticking time-bomb?

Yes, Starhub has high leverage

Judging from just the numbers alone, Starhub indeed has very high leverage – its total outstanding debt is currently S$687.5 million and yet it only has an equity value of S$94.5 million.

But yes, Starhub is still safe

Interestingly this actually seems like a great use of debt by Starhub’s management. Yes, you heard it right. Starhub has very high leverage, but it seems that the debt is actually good for the company.

Firstly, the interest on the borrowings are really low; Starhub is paying around S$20 million in interest expenses annually, which works out to an interest rate of around 2.9%. Due to the cheap financing, the company’s interest coverage ratio is more than 24 – that’s a very strong figure. In addition, the recurring nature of Starhub’s business (you wouldn’t cut your mobile phone plans even if Singapore’s economy slows down for a year or two, would you?) results in very stable earnings for the company, which means there is no real threat to Starhub’s ability to meet its interest payments.

Secondly, Starhub’s borrowings still have a number of years to go before they mature; the company’s bank loans of S$467.5 million are due within 5 years while its medium term notes worth S$220 million only comes due in 2022. As part of its medium term note programme, the company is able to raise addition borrowings up to a maximum of S$1 billion. Therefore, the company can easily refinance its bank loans with the programme when they are due.

Lastly, Starhub generates around S$300 million in free cash flow annually. When compared with its current total borrowings of S$687.5 million, the company has the ability to repay its loans within just three years even without its cash balance.  In other words, Starhub has the ability to pay down its loans relatively quickly if it chooses to do so.

Foolish Summary

All the above are great examples to show that not all use of debt is bad. Even though Starhub is considered to have very high debt levels, it is still a very stable and safe company due to its strong cash flows, low interest costs, and large financing optionality.

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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 doesn’t own shares in any companies mentioned.