Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Hollysys Automation Technologies Ltd. (NASDAQ:HOLI) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Hollysys Automation Technologies's Net Debt?
As you can see below, Hollysys Automation Technologies had US$23.2m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it does have US$477.6m in cash offsetting this, leading to net cash of US$454.5m.
How Healthy Is Hollysys Automation Technologies's Balance Sheet?
The latest balance sheet data shows that Hollysys Automation Technologies had liabilities of US$339.3m due within a year, and liabilities of US$22.6m falling due after that. On the other hand, it had cash of US$477.6m and US$553.0m worth of receivables due within a year. So it can boast US$668.8m more liquid assets than total liabilities.
This surplus liquidity suggests that Hollysys Automation Technologies's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, it seems its balance sheet is as strong as a black-belt karate master. Succinctly put, Hollysys Automation Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Hollysys Automation Technologies grew its EBIT at 12% over the last year, further increasing its ability to manage debt. 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 Hollysys Automation Technologies can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hollysys Automation Technologies 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. During the last three years, Hollysys Automation Technologies generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that Hollysys Automation Technologies has net cash of US$454m, as well as more liquid assets than liabilities. The cherry on top was that in converted 87% of that EBIT to free cash flow, bringing in US$97m. When it comes to Hollysys Automation Technologies's debt, we sufficiently relaxed that our mind turns to the jacuzzi. Over time, share prices tend to follow earnings per share, so if you're interested in Hollysys Automation Technologies, you may well want to click here to check an interactive graph of its earnings per share history.
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.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.