David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Hi-P International Limited (SGX:H17) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Hi-P International's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 Hi-P International had S$70.1m of debt, an increase on S$174, over one year. However, its balance sheet shows it holds S$246.4m in cash, so it actually has S$176.3m net cash.
How Strong Is Hi-P International's Balance Sheet?
The latest balance sheet data shows that Hi-P International had liabilities of S$554.6m due within a year, and liabilities of S$26.2m falling due after that. Offsetting these obligations, it had cash of S$246.4m as well as receivables valued at S$341.8m due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
This state of affairs indicates that Hi-P International's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the S$1.22b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Hi-P International boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that Hi-P International has seen its EBIT plunge 15% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hi-P International can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hi-P International 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. Over the last three years, Hi-P International 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 Hi-P International has net cash of S$176.3m, as well as more liquid assets than liabilities. The cherry on top was that in converted 152% of that EBIT to free cash flow, bringing in S$173m. So we don't have any problem with Hi-P International's use of debt. 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. To that end, you should be aware of the 1 warning sign we've spotted with Hi-P International .
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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