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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that 8VI Holdings Limited (ASX:8VI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is 8VI Holdings's Debt?
As you can see below, at the end of March 2022, 8VI Holdings had S$4.48m of debt, up from none a year ago. Click the image for more detail. But it also has S$26.1m in cash to offset that, meaning it has S$21.6m net cash.
A Look At 8VI Holdings' Liabilities
The latest balance sheet data shows that 8VI Holdings had liabilities of S$16.8m due within a year, and liabilities of S$4.86m falling due after that. Offsetting this, it had S$26.1m in cash and S$3.59m in receivables that were due within 12 months. So it can boast S$7.99m more liquid assets than total liabilities.
This short term liquidity is a sign that 8VI Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that 8VI Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that 8VI Holdings's load is not too heavy, because its EBIT was down 51% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since 8VI 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. 8VI 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, 8VI Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While we empathize with investors who find debt concerning, you should keep in mind that 8VI Holdings has net cash of S$21.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of S$5.5m, being 234% of its EBIT. So we don't have any problem with 8VI Holdings's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for 8VI Holdings you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.