Does Hong Kong Johnson Holdings (HKG:1955) Have A Healthy 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.' 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. We can see that Hong Kong Johnson Holdings Co., Ltd. (HKG:1955) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

See our latest analysis for Hong Kong Johnson Holdings

What Is Hong Kong Johnson Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Hong Kong Johnson Holdings had HK$17.0m of debt in March 2024, down from HK$28.3m, one year before. But it also has HK$429.5m in cash to offset that, meaning it has HK$412.5m net cash.

How Healthy Is Hong Kong Johnson Holdings' Balance Sheet?

According to the last reported balance sheet, Hong Kong Johnson Holdings had liabilities of HK$225.0m due within 12 months, and liabilities of HK$16.6m due beyond 12 months. On the other hand, it had cash of HK$429.5m and HK$264.2m worth of receivables due within a year. So it can boast HK$452.1m more liquid assets than total liabilities.

This excess liquidity is a great indication that Hong Kong Johnson Holdings' balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Hong Kong Johnson Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Hong Kong Johnson Holdings if management cannot prevent a repeat of the 63% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hong Kong Johnson 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. While Hong Kong Johnson Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Hong Kong Johnson Holdings recorded free cash flow worth a fulsome 81% 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 it is always sensible to investigate a company's debt, in this case Hong Kong Johnson Holdings has HK$412.5m in net cash and a strong balance sheet. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in -HK$12m. So we don't think Hong Kong Johnson 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. We've identified 3 warning signs with Hong Kong Johnson Holdings (at least 1 which is potentially serious) , 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.