Stock Analysis
The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 HBIS Company Limited (SZSE:000709) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.
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How Much Debt Does HBIS Carry?
As you can see below, at the end of September 2024, HBIS had CN¥121.9b of debt, up from CN¥112.8b a year ago. Click the image for more detail. However, it does have CN¥35.6b in cash offsetting this, leading to net debt of about CN¥86.3b.
A Look At HBIS' Liabilities
The latest balance sheet data shows that HBIS had liabilities of CN¥146.0b due within a year, and liabilities of CN¥57.1b falling due after that. On the other hand, it had cash of CN¥35.6b and CN¥12.9b worth of receivables due within a year. So it has liabilities totalling CN¥154.7b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the CN¥22.7b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, HBIS would likely require a major re-capitalisation if it had to pay its creditors today.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
HBIS shareholders face the double whammy of a high net debt to EBITDA ratio (7.0), and fairly weak interest coverage, since EBIT is just 1.5 times the interest expense. The debt burden here is substantial. More concerning, HBIS saw its EBIT drop by 6.0% in the last twelve months. If that earnings trend continues the company will face an uphill battle to pay off its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine HBIS's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, HBIS burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
To be frank both HBIS's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. We think the chances that HBIS has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for HBIS (1 is concerning) you should be aware of.
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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
About SZSE:000709
HBIS
Hbis Company Limited produces and sells steel products in China and internationally.