Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Hollysys Automation Technologies Ltd. (NASDAQ:HOLI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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 Hollysys Automation Technologies's Debt?
The image below, which you can click on for greater detail, shows that Hollysys Automation Technologies had debt of US$2.65m at the end of December 2019, a reduction from US$23.4m over a year. However, it does have US$550.6m in cash offsetting this, leading to net cash of US$548.0m.
A Look At Hollysys Automation Technologies's Liabilities
Zooming in on the latest balance sheet data, we can see that Hollysys Automation Technologies had liabilities of US$332.8m due within 12 months and liabilities of US$32.8m due beyond that. On the other hand, it had cash of US$550.6m and US$521.9m worth of receivables due within a year. So it can boast US$706.9m more liquid assets than total liabilities.
This surplus liquidity suggests that Hollysys Automation Technologies's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, Hollysys Automation Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that Hollysys Automation Technologies saw its EBIT decline by 6.8% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hollysys Automation Technologies'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 Hollysys Automation Technologies 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. Over the last three years, Hollysys Automation Technologies recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Hollysys Automation Technologies has net cash of US$548.0m, as well as more liquid assets than liabilities. The cherry on top was that in converted 95% of that EBIT to free cash flow, bringing in US$143m. So we don't think Hollysys Automation Technologies's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Hollysys Automation Technologies that you should be aware of before investing here.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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