These 4 Measures Indicate That AP Rentals Holdings (HKG:1496) Is Using Debt Safely

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. Importantly, AP Rentals Holdings Limited (HKG:1496) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 AP Rentals Holdings had HK$49.1m of debt, an increase on HK$34.1m, over one year. However, its balance sheet shows it holds HK$138.1m in cash, so it actually has HK$89.0m 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$94.7m falling due within a year, and liabilities of HK$22.0m due beyond that. On the other hand, it had cash of HK$138.1m and HK$5.55m worth of receivables due within a year. So it actually has HK$26.9m more liquid assets than total liabilities.

This surplus suggests that AP Rentals Holdings is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, AP Rentals Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, AP Rentals Holdings grew its EBIT by 122% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. 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. Over the last two years, AP Rentals Holdings recorded free cash flow worth a fulsome 92% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that AP Rentals Holdings has net cash of HK$89.0m, as well as more liquid assets than liabilities. The cherry on top was that in converted 92% of that EBIT to free cash flow, bringing in HK$4.2m. When it comes to AP Rentals Holdings's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for AP Rentals Holdings you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.