Dick Smith Holdings Ltd (ASX: DSH) is an Australian-listed retailer. It is unlikely that Singaporeans are familiar with the company given that its retail operations are seated in Australia and New Zealand.
But, the company should be of interest to investors here in Singapore.
Dick Smith had listed only in late 2013 but had fallen into administration earlier this month. So, less than three years had stood between the firm’s listing and collapse. Dick Smith’s rapid fall from grace is what makes it prominent for Singaporean investors as the episode contains an invaluable investing lesson: The importance of a strong balance sheet.
Shortly in the aftermath of Dick Smith’s failure, my Australian colleague Mike King had penned an article drawing threads between the firm’s experience and its weak balance sheet:
“Dick Smith lost the support of its bankers, who were unwilling to continue lending to the company to prop the business up. When a business requires debt to continue normal operations, that suggests there are fundamental underlying issues with the business.
Had Dick Smith had a decent cash balance and no debt, the retailer may well have been able to continue operating – and therein lies the lesson for investors. Instead, the retailer had taken on more than [A]$70 million of debt under three facilities allowing the retailer to borrow up to [A]$135 million.”
When investing, it’s crucial that we pore over a company’s balance sheet and assess how strong or weak it is. Having debt is not necessarily a bad thing as it can be used intelligently by a company’s management to produce higher returns. Some businesses – those with strong streams of recurring revenue or a “toll-booth” like nature – can also support the use of debt.
But, a balance sheet that is bloated with borrowings can severely crimp a company’s odds of making it through when the business environment inevitably swings south from time to time. Dick Smith is not a new example – the notable bankruptcy of Lehman Brothers during the Great Financial Crisis of 2007-09 had been a result of wanton use of debt too.
And even if high debt may not cause the outright failure of a company, it may also result in other painful consequences for its shareholders, such as the elimination of dividends or the forced sale of assets in order to raise cash to protect its balance sheet.
The good and the bad
In terms of balance sheet risks alone, companies such as Riverstone Holdings Limited (SGX: AP4), Super Group Ltd (SGX: S10), and Vicom Limited (SGX: V01) are relatively much safer than companies such as Noble Group Limited (SGX: N21), Ezra Holdings Limited (SGX: 5DN), and Eu Yan Sang International Ltd (SGX: E02).
The table below shows the amount of cash and debt that each of them have on their balance sheets at the moment. And as you can tell, Riverstone, Super, and Vicom have way more cash than debt, which is the opposite of Noble, Ezra, and Eu Yan Sang.
Of course – there are many other important areas of a company beyond its balance sheet that need to be researched before any investing decision can be reached. But, it is worth noting the dangers that can come with the use of debt and for that, a study of the balance sheet is a vital cog in the machine for investors.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Super Group and Vicom.