Here's Why Polyfair Holdings (HKG:8532) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Polyfair Holdings Limited (HKG:8532) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 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 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 Polyfair Holdings

What Is Polyfair Holdings's Debt?

As you can see below, Polyfair Holdings had HK$98.0m of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has HK$10.6m in cash leading to net debt of about HK$87.4m.

A Look At Polyfair Holdings' Liabilities

The latest balance sheet data shows that Polyfair Holdings had liabilities of HK$141.9m due within a year, and liabilities of HK$1.67m falling due after that. Offsetting this, it had HK$10.6m in cash and HK$150.5m in receivables that were due within 12 months. So it can boast HK$17.6m more liquid assets than total liabilities.

This surplus suggests that Polyfair Holdings is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.8 times and a disturbingly high net debt to EBITDA ratio of 11.1 hit our confidence in Polyfair Holdings like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. On the other hand, Polyfair Holdings grew its EBIT by 22% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Polyfair Holdings will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last two years, Polyfair Holdings's free cash flow amounted to 25% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We weren't impressed with Polyfair Holdings's interest cover, and its net debt to EBITDA made us cautious. But its EBIT growth rate was significantly redeeming. When we consider all the elements mentioned above, it seems to us that Polyfair Holdings is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Polyfair Holdings you should be aware of, and 3 of them don't sit too well with us.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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