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.' 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. Importantly, Midland IC&I Limited (HKG:459) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Midland IC&I Carry?
The image below, which you can click on for greater detail, shows that at December 2018 Midland IC&I had debt of HK$316.7m, up from HK$178.9m in one year. But on the other hand it also has HK$593.2m in cash, leading to a HK$276.5m net cash position.
How Strong Is Midland IC&I's Balance Sheet?
We can see from the most recent balance sheet that Midland IC&I had liabilities of HK$227.5m falling due within a year, and liabilities of HK$313.0m due beyond that. On the other hand, it had cash of HK$593.2m and HK$199.3m worth of receivables due within a year. So it can boast HK$252.1m more liquid assets than total liabilities.
This surplus liquidity suggests that Midland IC&I's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Midland IC&I has more cash than debt is arguably a good indication that it can manage its debt safely.
The modesty of its debt load may become crucial for Midland IC&I if management cannot prevent a repeat of the 21% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Midland IC&I will need earnings to service that debt. 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Midland IC&I 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. Looking at the most recent three years, Midland IC&I recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While it is always sensible to investigate a company's debt, in this case Midland IC&I has HK$276m in net cash and a strong balance sheet. So we don't think Midland IC&I's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Midland IC&I, you may well want to click here to check an interactive graph of its earnings per share history.
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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