BHCC Holding (HKG:1552) Seems To Use Debt Quite Sensibly

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. Importantly, BHCC Holding Limited (HKG:1552) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for BHCC Holding

How Much Debt Does BHCC Holding Carry?

As you can see below, at the end of December 2020, BHCC Holding had S$24.5m of debt, up from S$20.7m a year ago. Click the image for more detail. However, its balance sheet shows it holds S$44.9m in cash, so it actually has S$20.4m net cash.

A Look At BHCC Holding's Liabilities

We can see from the most recent balance sheet that BHCC Holding had liabilities of S$52.4m falling due within a year, and liabilities of S$23.3m due beyond that. Offsetting this, it had S$44.9m in cash and S$41.1m in receivables that were due within 12 months. So it actually has S$10.2m more liquid assets than total liabilities.

This luscious liquidity implies that BHCC Holding's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that BHCC Holding has more cash than debt is arguably a good indication that it can manage its debt safely.

Shareholders should be aware that BHCC Holding's EBIT was down 70% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since BHCC Holding 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While BHCC Holding 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. Looking at the most recent three years, BHCC Holding recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that BHCC Holding has net cash of S$20.4m, as well as more liquid assets than liabilities. So we are not troubled with BHCC Holding's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example BHCC Holding has 5 warning signs (and 2 which are a bit unpleasant) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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