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'. 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 note that Xinyi Automobile Glass Hong Kong Enterprises Limited (HKG:8328) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Xinyi Automobile Glass Hong Kong Enterprises Carry?
As you can see below, at the end of December 2019, Xinyi Automobile Glass Hong Kong Enterprises had HK$30.0m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds HK$220.9m in cash, so it actually has HK$190.9m net cash.
A Look At Xinyi Automobile Glass Hong Kong Enterprises's Liabilities
The latest balance sheet data shows that Xinyi Automobile Glass Hong Kong Enterprises had liabilities of HK$91.7m due within a year, and liabilities of HK$6.24m falling due after that. On the other hand, it had cash of HK$220.9m and HK$71.0m worth of receivables due within a year. So it actually has HK$193.9m more liquid assets than total liabilities.
This excess liquidity suggests that Xinyi Automobile Glass Hong Kong Enterprises is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Xinyi Automobile Glass Hong Kong Enterprises has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Xinyi Automobile Glass Hong Kong Enterprises has boosted its EBIT by 34%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Xinyi Automobile Glass Hong Kong Enterprises will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Xinyi Automobile Glass Hong Kong Enterprises 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, Xinyi Automobile Glass Hong Kong Enterprises saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
While it is always sensible to investigate a company's debt, in this case Xinyi Automobile Glass Hong Kong Enterprises has HK$190.9m in net cash and a decent-looking balance sheet. And we liked the look of last year's 34% year-on-year EBIT growth. So is Xinyi Automobile Glass Hong Kong Enterprises's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Xinyi Automobile Glass Hong Kong Enterprises you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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