Analogue Holdings (HKG:1977) Has A Rock Solid Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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, Analogue Holdings Limited (HKG:1977) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 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, 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.

View our latest analysis for Analogue Holdings

How Much Debt Does Analogue Holdings Carry?

The image below, which you can click on for greater detail, shows that at June 2022 Analogue Holdings had debt of HK$285.6m, up from HK$8.37m in one year. But on the other hand it also has HK$1.07b in cash, leading to a HK$788.1m net cash position.

How Healthy Is Analogue Holdings' Balance Sheet?

According to the last reported balance sheet, Analogue Holdings had liabilities of HK$2.19b due within 12 months, and liabilities of HK$335.2m due beyond 12 months. On the other hand, it had cash of HK$1.07b and HK$2.10b worth of receivables due within a year. So it actually has HK$648.8m more liquid assets than total liabilities.

This excess liquidity is a great indication that Analogue Holdings' balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Analogue Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Analogue Holdings has been able to increase its EBIT by 22% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Analogue Holdings 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Analogue 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. Happily for any shareholders, Analogue Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Analogue Holdings has HK$788.1m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$436m, being 121% of its EBIT. When it comes to Analogue Holdings's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. For example Analogue Holdings has 2 warning signs (and 1 which is potentially serious) we think 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.