David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Hi-P International Limited (SGX:H17) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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 Hi-P International Carry?
As you can see below, Hi-P International had S$103.1m of debt at June 2019, down from S$196.3m a year prior. However, its balance sheet shows it holds S$248.9m in cash, so it actually has S$145.8m net cash.
How Healthy Is Hi-P International's Balance Sheet?
The latest balance sheet data shows that Hi-P International had liabilities of S$467.8m due within a year, and liabilities of S$28.3m falling due after that. On the other hand, it had cash of S$248.9m and S$257.0m worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
This state of affairs indicates that Hi-P International's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the S$1.11b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Hi-P International boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Hi-P International's load is not too heavy, because its EBIT was down 24% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Hi-P International can strengthen its balance sheet over time. 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. Hi-P International 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. Over the last three years, Hi-P International actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While we empathize with investors who find debt concerning, you should keep in mind that Hi-P International has net cash of S$146m, as well as more liquid assets than liabilities. The cherry on top was that in converted 151% of that EBIT to free cash flow, bringing in S$153m. So we don't have any problem with Hi-P International's use of debt. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Hi-P International's dividend history, without delay!
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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