The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Wai Hung Group Holdings Limited (HKG:3321) does carry debt. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
What Is Wai Hung Group Holdings's Debt?
The image below, which you can click on for greater detail, shows that Wai Hung Group Holdings had debt of MO$2.58m at the end of December 2018, a reduction from MO$5.14m over a year. However, its balance sheet shows it holds MO$11.2m in cash, so it actually has MO$8.64m net cash.
A Look At Wai Hung Group Holdings's Liabilities
According to the balance sheet data, Wai Hung Group Holdings had liabilities of MO$55.3m due within 12 months, but no longer term liabilities. Offsetting these obligations, it had cash of MO$11.2m as well as receivables valued at MO$73.4m due within 12 months. So it actually has MO$29.3m more liquid assets than total liabilities.
This short term liquidity is a sign that Wai Hung Group Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Wai Hung Group Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Wai Hung Group Holdings has boosted its EBIT by 50%, thus reducing the spectre of future debt repayments. 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 Wai Hung Group 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. Wai Hung 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. In the last three years, Wai Hung Group Holdings's free cash flow amounted to 33% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While it is always sensible to investigate a company's debt, in this case Wai Hung Group Holdings has MO$8.6m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 50% over the last year. So we don't think Wai Hung Group Holdings's use of debt is risky. We'd be motivated to research the stock further if we found out that Wai Hung Group Holdings insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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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