Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Hingtex Holdings Limited (HKG:1968) does carry debt. But is this debt a concern to shareholders?
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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Hingtex Holdings's Debt?
As you can see below, at the end of December 2018, Hingtex Holdings had HK$108.0m of debt, up from HK$83.7m a year ago. Click the image for more detail. But it also has HK$185.1m in cash to offset that, meaning it has HK$77.2m net cash.
How Healthy Is Hingtex Holdings's Balance Sheet?
According to the last reported balance sheet, Hingtex Holdings had liabilities of HK$231.8m due within 12 months, and liabilities of HK$10.3m due beyond 12 months. Offsetting this, it had HK$185.1m in cash and HK$82.4m in receivables that were due within 12 months. So it actually has HK$25.4m more liquid assets than total liabilities.
This short term liquidity is a sign that Hingtex Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Hingtex Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that Hingtex Holdings has seen its EBIT plunge 18% 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 it is Hingtex Holdings's earnings that will influence how the balance sheet holds up in the future. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hingtex 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. Considering the last three years, Hingtex Holdings actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
While it is always sensible to investigate a company's debt, in this case Hingtex Holdings has HK$77m in net cash and a decent-looking balance sheet. So we are not troubled with Hingtex Holdings's debt use. Given Hingtex Holdings has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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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