FSE Lifestyle Services (HKG:331) Seems To Use Debt Rather Sparingly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, FSE Lifestyle Services Limited (HKG:331) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for FSE Lifestyle Services

What Is FSE Lifestyle Services's Debt?

The image below, which you can click on for greater detail, shows that FSE Lifestyle Services had debt of HK$263.7m at the end of December 2020, a reduction from HK$562.8m over a year. But on the other hand it also has HK$822.0m in cash, leading to a HK$558.3m net cash position.

A Look At FSE Lifestyle Services' Liabilities

The latest balance sheet data shows that FSE Lifestyle Services had liabilities of HK$2.36b due within a year, and liabilities of HK$77.1m falling due after that. Offsetting these obligations, it had cash of HK$822.0m as well as receivables valued at HK$1.80b due within 12 months. So it can boast HK$181.6m more liquid assets than total liabilities.

This short term liquidity is a sign that FSE Lifestyle Services could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that FSE Lifestyle Services has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, FSE Lifestyle Services grew its EBIT by 62% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is FSE Lifestyle Services'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. FSE Lifestyle Services 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. During the last three years, FSE Lifestyle Services generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case FSE Lifestyle Services has HK$558.3m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$820m, being 83% of its EBIT. So is FSE Lifestyle Services's debt a risk? It doesn't seem so to us. 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 - FSE Lifestyle Services has 2 warning signs we think you should be aware of.

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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