Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Wah Sun Handbags International Holdings Limited (HKG:2683) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Wah Sun Handbags International Holdings Carry?
The image below, which you can click on for greater detail, shows that Wah Sun Handbags International Holdings had debt of HK$17.3m at the end of March 2019, a reduction from HK$20.2m over a year. However, it does have HK$93.8m in cash offsetting this, leading to net cash of HK$76.5m.
How Healthy Is Wah Sun Handbags International Holdings's Balance Sheet?
According to the last reported balance sheet, Wah Sun Handbags International Holdings had liabilities of HK$242.6m due within 12 months, and liabilities of HK$705.0k due beyond 12 months. Offsetting these obligations, it had cash of HK$93.8m as well as receivables valued at HK$145.9m due within 12 months. So these liquid assets roughly match the total liabilities.
Having regard to Wah Sun Handbags International Holdings's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the HK$224.7m company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Wah Sun Handbags International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Wah Sun Handbags International Holdings's load is not too heavy, because its EBIT was down 49% 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 it is Wah Sun Handbags International Holdings'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. While Wah Sun Handbags International Holdings 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. In the last three years, Wah Sun Handbags International Holdings's free cash flow amounted to 28% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
We could understand if investors are concerned about Wah Sun Handbags International Holdings's liabilities, but we can be reassured by the fact it has has net cash of HK$77m. So we don't have any problem with Wah Sun Handbags International Holdings's use of debt. Given Wah Sun Handbags International Holdings has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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