Is AB Builders Group (HKG:1615) Using Too Much Debt?

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. As with many other companies AB Builders Group Limited (HKG:1615) makes use of debt. But the real question is whether this debt is making the company risky.

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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for AB Builders Group

What Is AB Builders Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 AB Builders Group had MO$17.0m of debt, an increase on none, over one year. But it also has MO$124.7m in cash to offset that, meaning it has MO$107.7m net cash.

A Look At AB Builders Group's Liabilities

According to the last reported balance sheet, AB Builders Group had liabilities of MO$129.6m due within 12 months, and liabilities of MO$948.0k due beyond 12 months. Offsetting this, it had MO$124.7m in cash and MO$64.3m in receivables that were due within 12 months. So it can boast MO$58.5m more liquid assets than total liabilities.

This excess liquidity is a great indication that AB Builders Group's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that AB Builders Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Although AB Builders Group made a loss at the EBIT level, last year, it was also good to see that it generated MO$3.0m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since AB Builders Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While AB Builders Group 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. Over the last year, AB Builders Group actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that AB Builders Group has net cash of MO$107.7m, as well as more liquid assets than liabilities. The cherry on top was that in converted 1,924% of that EBIT to free cash flow, bringing in MO$58m. So we don't think AB Builders Group's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for AB Builders Group you should be aware of, and 1 of them is significant.

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.