Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about. 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, Affluent Foundation Holdings Limited (HKG:1757) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Affluent Foundation Holdings Carry?
As you can see below, at the end of September 2019, Affluent Foundation Holdings had HK$43.3m of debt, up from HK$17.9m a year ago. Click the image for more detail. On the flip side, it has HK$32.5m in cash leading to net debt of about HK$10.7m.
How Healthy Is Affluent Foundation Holdings’s Balance Sheet?
According to the last reported balance sheet, Affluent Foundation Holdings had liabilities of HK$115.3m due within 12 months, and liabilities of HK$7.82m due beyond 12 months. Offsetting this, it had HK$32.5m in cash and HK$151.8m in receivables that were due within 12 months. So it can boast HK$61.3m more liquid assets than total liabilities.
This surplus suggests that Affluent Foundation Holdings is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. When analysing debt levels, the balance sheet is the obvious place to start. But it is Affluent Foundation 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.
In the last year Affluent Foundation Holdings had negative earnings before interest and tax, and actually shrunk its revenue by 49%, to HK$241m. To be frank that doesn’t bode well.
While Affluent Foundation Holdings’s falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping HK$93m. Looking on the brighter side, the business has adequate liquid assets, which give it time to grow and develop before its debt becomes a near-term issue. But we’d want to see some positive free cashflow before spending much time on trying to understand the stock. This one is a bit too risky for our liking. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We’ve identified 5 warning signs with Affluent Foundation Holdings (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.
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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