Here's Why E-Commodities Holdings (HKG:1733) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, E-Commodities Holdings Limited (HKG:1733) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for E-Commodities Holdings

What Is E-Commodities Holdings's Debt?

As you can see below, E-Commodities Holdings had HK$700.7m of debt at June 2023, down from HK$2.23b a year prior. But on the other hand it also has HK$3.70b in cash, leading to a HK$3.00b net cash position.

How Strong Is E-Commodities Holdings' Balance Sheet?

According to the last reported balance sheet, E-Commodities Holdings had liabilities of HK$5.01b due within 12 months, and liabilities of HK$572.2m due beyond 12 months. Offsetting these obligations, it had cash of HK$3.70b as well as receivables valued at HK$3.02b due within 12 months. So it actually has HK$1.14b more liquid assets than total liabilities.

This surplus strongly suggests that E-Commodities Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that E-Commodities Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact E-Commodities Holdings's saving grace is its low debt levels, because its EBIT has tanked 50% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is E-Commodities Holdings's earnings that will influence how the balance sheet holds up in the future. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. E-Commodities 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 most recent three years, E-Commodities Holdings recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case E-Commodities Holdings has HK$3.00b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$3.0b, being 72% of its EBIT. So is E-Commodities Holdings's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. 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 2 warning signs for E-Commodities Holdings you should know about.

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.