Is E. Bon Holdings (HKG:599) Using Too Much Debt?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, E. Bon Holdings Limited (HKG:599) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for E. Bon Holdings

What Is E. Bon Holdings's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 E. Bon Holdings had debt of HK$54.3m, up from HK$51.6m in one year. However, it does have HK$84.4m in cash offsetting this, leading to net cash of HK$30.2m.

How Healthy Is E. Bon Holdings' Balance Sheet?

According to the last reported balance sheet, E. Bon Holdings had liabilities of HK$187.0m due within 12 months, and liabilities of HK$55.8m due beyond 12 months. On the other hand, it had cash of HK$84.4m and HK$149.3m worth of receivables due within a year. So its liabilities total HK$9.11m more than the combination of its cash and short-term receivables.

Since publicly traded E. Bon Holdings shares are worth a total of HK$246.2m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, E. Bon Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that E. Bon Holdings's EBIT was down 21% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is E. Bon Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. E. Bon 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. Happily for any shareholders, E. Bon Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

We could understand if investors are concerned about E. Bon Holdings's liabilities, but we can be reassured by the fact it has has net cash of HK$30.2m. The cherry on top was that in converted 214% of that EBIT to free cash flow, bringing in -HK$12m. So we don't have any problem with E. Bon Holdings's use of debt. 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. We've identified 3 warning signs with E. Bon Holdings (at least 1 which is significant) , and understanding them should be part of your investment process.

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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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.