Is AP Rentals Holdings (HKG:1496) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that AP Rentals Holdings Limited (HKG:1496) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for AP Rentals Holdings

What Is AP Rentals Holdings's Debt?

As you can see below, at the end of September 2023, AP Rentals Holdings had HK$34.1m of debt, up from HK$24.1m a year ago. Click the image for more detail. But it also has HK$78.7m in cash to offset that, meaning it has HK$44.6m net cash.

A Look At AP Rentals Holdings' Liabilities

We can see from the most recent balance sheet that AP Rentals Holdings had liabilities of HK$75.6m falling due within a year, and liabilities of HK$25.2m due beyond that. Offsetting this, it had HK$78.7m in cash and HK$36.6m in receivables that were due within 12 months. So it actually has HK$14.5m more liquid assets than total liabilities.

This surplus suggests that AP Rentals Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, AP Rentals Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, AP Rentals Holdings turned things around in the last 12 months, delivering and EBIT of HK$5.5m. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since AP Rentals Holdings 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. AP Rentals Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, AP Rentals Holdings actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case AP Rentals Holdings has HK$44.6m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$12m, being 220% of its EBIT. So we don't think AP Rentals Holdings's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for AP Rentals Holdings you should know about.

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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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.