Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk. 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. We can see that Vantage International (Holdings) Limited (HKG:15) does use debt in its business. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. 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.
What Is Vantage International (Holdings)’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that Vantage International (Holdings) had HK$1.31b of debt in September 2019, down from HK$1.37b, one year before. However, because it has a cash reserve of HK$796.2m, its net debt is less, at about HK$514.5m.
A Look At Vantage International (Holdings)’s Liabilities
According to the last reported balance sheet, Vantage International (Holdings) had liabilities of HK$1.99b due within 12 months, and liabilities of HK$9.18m due beyond 12 months. Offsetting these obligations, it had cash of HK$796.2m as well as receivables valued at HK$682.8m due within 12 months. So its liabilities total HK$523.8m more than the combination of its cash and short-term receivables.
Vantage International (Holdings) has a market capitalization of HK$925.7m, 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.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Vantage International (Holdings)’s net debt is only 1.0 times its EBITDA. And its EBIT covers its interest expense a whopping 21.5 times over. So we’re pretty relaxed about its super-conservative use of debt. While Vantage International (Holdings) doesn’t seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 Vantage International (Holdings) will need earnings to service that debt. 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it’s worth checking how much of that EBIT is backed by free cash flow. During the last three years, Vantage International (Holdings) produced sturdy free cash flow equating to 69% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
Vantage International (Holdings)’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 truth be told we feel its level of total liabilities does undermine this impression a bit. All these things considered, it appears that Vantage International (Holdings) can comfortably handle its current debt levels. 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. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Vantage International (Holdings)’s dividend history, without delay!
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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