We Think Huarchi Global Group Holdings (HKG:2296) Can Manage Its Debt With Ease
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Huarchi Global Group Holdings Limited (HKG:2296) makes use of debt. But is this debt a concern to shareholders?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Huarchi Global Group Holdings
What Is Huarchi Global Group Holdings's Debt?
As you can see below, Huarchi Global Group Holdings had MO$46.2m of debt at December 2019, down from MO$52.3m a year prior. However, it does have MO$131.5m in cash offsetting this, leading to net cash of MO$85.3m.
A Look At Huarchi Global Group Holdings's Liabilities
Zooming in on the latest balance sheet data, we can see that Huarchi Global Group Holdings had liabilities of MO$160.3m due within 12 months and no liabilities due beyond that. Offsetting these obligations, it had cash of MO$131.5m as well as receivables valued at MO$253.3m due within 12 months. So it can boast MO$224.6m more liquid assets than total liabilities.
This surplus liquidity suggests that Huarchi Global Group Holdings's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Huarchi Global Group Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
And we also note warmly that Huarchi Global Group Holdings grew its EBIT by 20% last year, making its debt load easier to handle. 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 Huarchi Global Group Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Huarchi Global Group Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Huarchi Global Group Holdings reported free cash flow worth 15% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
Summing up
While it is always sensible to investigate a company's debt, in this case Huarchi Global Group Holdings has MO$85.3m in net cash and a decent-looking balance sheet. And we liked the look of last year's 20% year-on-year EBIT growth. So we don't think Huarchi Global Group Holdings's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Huarchi Global Group Holdings has 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
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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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.
