Here's Why Wing Fung Group Asia (HKG:8526) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Wing Fung Group Asia Limited (HKG:8526) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Wing Fung Group Asia

How Much Debt Does Wing Fung Group Asia Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Wing Fung Group Asia had HK$38.2m of debt, an increase on HK$6.45m, over one year. However, it also had HK$18.7m in cash, and so its net debt is HK$19.5m.

How Strong Is Wing Fung Group Asia's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wing Fung Group Asia had liabilities of HK$91.3m due within 12 months and liabilities of HK$536.0k due beyond that. On the other hand, it had cash of HK$18.7m and HK$173.0m worth of receivables due within a year. So it can boast HK$99.9m more liquid assets than total liabilities.

This excess liquidity is a great indication that Wing Fung Group Asia's 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Wing Fung Group Asia's net debt is only 0.75 times its EBITDA. And its EBIT easily covers its interest expense, being 33.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that Wing Fung Group Asia saw its EBIT decline by 2.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Wing Fung Group Asia'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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Wing Fung Group Asia saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Happily, Wing Fung Group Asia's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Wing Fung Group Asia can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Wing Fung Group Asia is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

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. 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.
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