Risk could be one of the most misunderstood things about investing. Many investors use a stock’s price movement – its volatility – as a way to measure its risk. But, doing so may not be a good idea. Over the long-term, a stock’s price is linked to the performance of its business. “If a business does well,” billionaire investor Warren Buffett once said, “the stock eventually follows.” As such, focusing on a stock’s business fundamentals as a way to measure its risk may make a lot more sense than looking at price-volatility. With this in mind, just how risky is…
Risk could be one of the most misunderstood things about investing. Many investors use a stock’s price movement – its volatility – as a way to measure its risk. But, doing so may not be a good idea.
Over the long-term, a stock’s price is linked to the performance of its business. “If a business does well,” billionaire investor Warren Buffett once said, “the stock eventually follows.” As such, focusing on a stock’s business fundamentals as a way to measure its risk may make a lot more sense than looking at price-volatility.
With this in mind, just how risky is marine engineering and property development outfit Keppel Corporation Limited (SGX: BN4) as an investment? There are many other areas of the company’s business fundamentals to look at, but in here, let’s focus on two important aspects:
1. Balance sheet risk
The presence of high levels of debt in a balance sheet can make a company fragile. Walter Schloss, an investor with a phenomenal long-term investing track record, once said, “I like to look at the balance sheet and I don’t like debt because it can really get a company into trouble.”
On the other hand, a strong balance sheet – one that is flush with cash and with little debt – can be a valuable asset. It gives a company higher odds of surviving tough economic climates unscathed. It can even provide a company with the platform to go on the offensive during downturns and gain competitive advantages over weaker competitors that have to batten down their hatches to ride out storms.
In the case of Keppel Corp, there may be some cause for worry. Here’s a chart showing how the company’s net-debt (total borrowings minus cash and short-term investments) to equity ratio has changed over the past decade:
Source: S&P Global Market Intelligence
As of 31 December 2015, Keppel Corp had S$11.9 billion in total equity, S$8.26 billion in total debt, and just S$2.12 billion in cash and short-term investments, giving rise to a net-debt to equity ratio of over 50%. That’s a high ratio. While it’s not dangerously high yet, that net-debt to equity ratio is still the highest it’s been over the past decade.
In a situation that may be akin to adding fuel to fire, the oil & gas industry is caught in a rough spot at the moment with the price of oil having fallen by over half from more than US$100 per barrel in mid-2014 to around US$40 today. Keppel Corp currently depends on its Offshore & Marine business segment – one of the world’s largest builder of oil rigs – for 61% of its revenue.
2. Customer concentration risk
It can be dangerous for a company to depend on only a handful of customers for its business. If just one of its customers collapses or walks away, the consequences can be ugly.
The U.S.-based sapphire glass products manufacturer GT Advanced Technologies is a good example. In late 2014, the company had to file for bankruptcy when its product failed to meet the requirements of its customer, Apple Inc. At that time, it was likely that GT Advanced Technologies had depended on Apple for the lion’s share of its revenue.
For Keppel Corp, it does not appear to have much customer concentration issues to fret over. In the firm’s latest 2015 annual report, it was stated that no single customer had accounted for 10% or more of total revenue that year. For perspective, Keppel Corp had ended 2015 with S$10.3 billion in revenue.
A Fool’s take
Given what we’ve seen about Keppel Corp, I think it’s fair to say that the company has a high level of balance sheet risk but low customer concentration risk.
As for the question on just how risky Keppel Corp is as an investment, this look at the firm’s balance sheet and level of customer concentration may be useful, but they are not sufficient to come to a firm conclusion. Like I had mentioned earlier, there are other aspects of Keppel Corp’s business fundamentals to consider.
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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 writer Chong Ser Jing doesn't own shares in any companies mentioned.