Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Stella International Holdings Limited (HKG:1836) makes use of debt. But the real question is whether this debt is making the company risky.
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Stella International Holdings Carry?
The chart below, which you can click on for greater detail, shows that Stella International Holdings had US$65.4m in debt in December 2018; about the same as the year before. However, its balance sheet shows it holds US$184.9m in cash, so it actually has US$119.5m net cash.
A Look At Stella International Holdings's Liabilities
The latest balance sheet data shows that Stella International Holdings had liabilities of US$216.8m due within a year, and liabilities of US$2.92m falling due after that. Offsetting this, it had US$184.9m in cash and US$345.3m in receivables that were due within 12 months. So it can boast US$310.5m more liquid assets than total liabilities.
This excess liquidity suggests that Stella International Holdings is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Stella International Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that Stella International Holdings grew its EBIT at 16% 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 it is future earnings, more than anything, that will determine Stella International Holdings's ability to maintain a healthy balance sheet going forward. 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. While Stella International Holdings 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. During the last three years, Stella International Holdings produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to investigate a company's debt, in this case Stella International Holdings has US$120m in net cash and a decent-looking balance sheet. And we liked the look of last year's 16% year-on-year EBIT growth. So is Stella International Holdings's debt a risk? It doesn't seem so to us. We'd be very excited to see if Stella International Holdings insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
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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