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. As with many other companies AUX International Holdings Limited (HKG:2080) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for AUX International Holdings

What Is AUX International Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2019 AUX International Holdings had HK$109.9m of debt, an increase on HK$114, over one year. But it also has HK$223.9m in cash to offset that, meaning it has HK$114.0m net cash.

How Strong Is AUX International Holdings's Balance Sheet?

According to the last reported balance sheet, AUX International Holdings had liabilities of HK$171.3m due within 12 months, and liabilities of HK$128.4m due beyond 12 months. Offsetting these obligations, it had cash of HK$223.9m as well as receivables valued at HK$63.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$12.4m.

Given AUX International Holdings has a market capitalization of HK$187.5m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, AUX International Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, AUX International Holdings turned things around in the last 12 months, delivering and EBIT of HK$10m. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since AUX International Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While AUX International Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, AUX International Holdings actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

We could understand if investors are concerned about AUX International Holdings's liabilities, but we can be reassured by the fact it has has net cash of HK$114.0m. The cherry on top was that in converted 170% of that EBIT to free cash flow, bringing in HK$18m. So we don't think AUX International Holdings's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for AUX International Holdings (1 makes us a bit uncomfortable) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.