Is Impro Precision Industries (HKG:1286) A Risky Investment?

By
Simply Wall St
Published
April 13, 2022
SEHK:1286
Source: Shutterstock

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.' 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, Impro Precision Industries Limited (HKG:1286) does carry debt. But the real question is whether this debt is making the company risky.

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Impro Precision Industries

What Is Impro Precision Industries's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Impro Precision Industries had HK$1.53b of debt, an increase on HK$816.1m, over one year. However, because it has a cash reserve of HK$579.0m, its net debt is less, at about HK$949.9m.

debt-equity-history-analysis
SEHK:1286 Debt to Equity History April 13th 2022

A Look At Impro Precision Industries' Liabilities

Zooming in on the latest balance sheet data, we can see that Impro Precision Industries had liabilities of HK$1.58b due within 12 months and liabilities of HK$1.08b due beyond that. On the other hand, it had cash of HK$579.0m and HK$1.10b worth of receivables due within a year. So its liabilities total HK$983.0m more than the combination of its cash and short-term receivables.

Impro Precision Industries has a market capitalization of HK$4.12b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Impro Precision Industries has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 22.2 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, Impro Precision Industries grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Impro Precision Industries can strengthen its balance sheet over time. 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Impro Precision Industries's free cash flow amounted to 23% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Impro Precision Industries's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that Impro Precision Industries can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Impro Precision Industries (including 1 which is significant) .

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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