Wai Kee Holdings (HKG:610) Has A Rock Solid Balance Sheet

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. We can see that Wai Kee Holdings Limited (HKG:610) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Wai Kee Holdings

What Is Wai Kee Holdings's Net Debt?

The chart below, which you can click on for greater detail, shows that Wai Kee Holdings had HK$1.16b in debt in December 2020; about the same as the year before. However, its balance sheet shows it holds HK$2.41b in cash, so it actually has HK$1.25b net cash.

How Strong Is Wai Kee Holdings' Balance Sheet?

We can see from the most recent balance sheet that Wai Kee Holdings had liabilities of HK$4.38b falling due within a year, and liabilities of HK$446.7m due beyond that. Offsetting these obligations, it had cash of HK$2.41b as well as receivables valued at HK$2.49b due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This surplus suggests that Wai Kee Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Wai Kee Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Wai Kee Holdings grew its EBIT at 12% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Wai Kee 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Wai Kee 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 last three years, Wai Kee Holdings recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Wai Kee Holdings has net cash of HK$1.25b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of -HK$181m, being 90% of its EBIT. So we don't think Wai Kee Holdings'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. To that end, you should be aware of the 1 warning sign we've spotted with Wai Kee Holdings .

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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