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. We note that FIT Hon Teng Limited (HKG:6088) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. 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. 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 FIT Hon Teng's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 FIT Hon Teng had US$887.7m of debt, an increase on US$384.9m, over one year. But on the other hand it also has US$1.07b in cash, leading to a US$181.7m net cash position.
How Strong Is FIT Hon Teng's Balance Sheet?
According to the last reported balance sheet, FIT Hon Teng had liabilities of US$1.61b due within 12 months, and liabilities of US$686.4m due beyond 12 months. On the other hand, it had cash of US$1.07b and US$865.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$364.0m.
Of course, FIT Hon Teng has a market capitalization of US$2.96b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, FIT Hon Teng also has more cash than debt, so we're pretty confident it can manage its debt safely.
But the other side of the story is that FIT Hon Teng saw its EBIT decline by 8.1% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 FIT Hon Teng can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While FIT Hon Teng 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, FIT Hon Teng generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Although FIT Hon Teng's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$181.7m. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in US$372m. So we are not troubled with FIT Hon Teng's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of FIT Hon Teng's earnings per share history for free.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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