Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Billion Industrial Holdings Limited (HKG:2299) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
What Is Billion Industrial Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that Billion Industrial Holdings had debt of CN¥1.74b at the end of June 2019, a reduction from CN¥4.08b over a year. However, its balance sheet shows it holds CN¥2.20b in cash, so it actually has CN¥453.6m net cash.
A Look At Billion Industrial Holdings's Liabilities
Zooming in on the latest balance sheet data, we can see that Billion Industrial Holdings had liabilities of CN¥7.57b due within 12 months and liabilities of CN¥407.5m due beyond that. Offsetting these obligations, it had cash of CN¥2.20b as well as receivables valued at CN¥126.5m due within 12 months. So it has liabilities totalling CN¥5.65b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Billion Industrial Holdings has a market capitalization of CN¥12.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Billion Industrial Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
It is well worth noting that Billion Industrial Holdings's EBIT shot up like bamboo after rain, gaining 43% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Billion Industrial 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Billion Industrial 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, Billion Industrial Holdings generated free cash flow amounting to a very robust 95% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Although Billion Industrial Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥454m. And it impressed us with free cash flow of CN¥1.9b, being 95% of its EBIT. So is Billion Industrial Holdings's debt a risk? It doesn't seem so to us. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Billion Industrial Holdings insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying 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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