In Construction Holdings (HKG:1500) Could Easily Take On More Debt

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, In Construction Holdings Limited (HKG:1500) does carry debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

See our latest analysis for In Construction Holdings

What Is In Construction Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that In Construction Holdings had debt of HK$13.0m at the end of September 2020, a reduction from HK$25.0m over a year. However, it does have HK$51.9m in cash offsetting this, leading to net cash of HK$38.9m.

How Healthy Is In Construction Holdings's Balance Sheet?

The latest balance sheet data shows that In Construction Holdings had liabilities of HK$121.3m due within a year, and liabilities of HK$12.8m falling due after that. Offsetting these obligations, it had cash of HK$51.9m as well as receivables valued at HK$338.6m due within 12 months. So it can boast HK$256.3m more liquid assets than total liabilities.

This luscious liquidity implies that In Construction Holdings's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Simply put, the fact that In Construction Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that In Construction Holdings has boosted its EBIT by 92%, thus reducing the spectre of future debt repayments. 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 In Construction 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While In Construction Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last two years, In Construction Holdings burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case In Construction Holdings has HK$38.9m in net cash and a strong balance sheet. And it impressed us with its EBIT growth of 92% over the last year. So we don't think In Construction Holdings's use of debt is risky. 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. Be aware that In Construction Holdings is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

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. 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.
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