Here's Why Seeka (NZSE:SEK) Has A Meaningful Debt Burden
Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Seeka Limited (NZSE:SEK) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Seeka
How Much Debt Does Seeka Carry?
As you can see below, Seeka had NZ$80.7m of debt at December 2018, down from NZ$85.6m a year prior. Net debt is about the same, since the it doesn't have much cash.
A Look At Seeka's Liabilities
We can see from the most recent balance sheet that Seeka had liabilities of NZ$40.2m falling due within a year, and liabilities of NZ$76.2m due beyond that. On the other hand, it had cash of NZ$1.34m and NZ$17.3m worth of receivables due within a year. So its liabilities total NZ$97.8m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of NZ$157.1m, so it does suggest shareholders should keep an eye on Seeka's use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Seeka's debt is 3.3 times its EBITDA, and its EBIT cover its interest expense 3.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that Seeka improved its EBIT by 4.6% over the last twelve years, thus gradually reducing its debt levels relative to its earnings. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Seeka's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Seeka saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
We'd go so far as to say Seeka's conversion of EBIT to free cash flow was disappointing. Having said that, its ability to grow its EBIT isn't such a worry. Looking at the bigger picture, it seems clear to us that Seeka's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. Given Seeka has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
