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 The Hour Glass Limited (SGX:AGS) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Hour Glass's Debt?
The image below, which you can click on for greater detail, shows that Hour Glass had debt of S$17.5m at the end of June 2019, a reduction from S$47.0m over a year. However, it does have S$190.8m in cash offsetting this, leading to net cash of S$173.3m.
How Healthy Is Hour Glass's Balance Sheet?
We can see from the most recent balance sheet that Hour Glass had liabilities of S$90.5m falling due within a year, and liabilities of S$93.1m due beyond that. Offsetting these obligations, it had cash of S$190.8m as well as receivables valued at S$20.1m due within 12 months. So it can boast S$27.3m more liquid assets than total liabilities.
This surplus suggests that Hour Glass has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Hour Glass has more cash than debt is arguably a good indication that it can manage its debt safely.
And we also note warmly that Hour Glass grew its EBIT by 20% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hour Glass'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. Hour Glass 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, Hour Glass recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company's debt, in this case Hour Glass has S$173m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 97% of that EBIT to free cash flow, bringing in S$51m. So we don't think Hour Glass's use of debt is risky. Another factor that would give us confidence in Hour Glass would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
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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