Hong Kong Johnson Holdings (HKG:1955) Could Easily Take On More Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Hong Kong Johnson Holdings Co., Ltd. (HKG:1955) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hong Kong Johnson Holdings

How Much Debt Does Hong Kong Johnson Holdings Carry?

The image below, which you can click on for greater detail, shows that Hong Kong Johnson Holdings had debt of HK$23.9m at the end of September 2023, a reduction from HK$197.1m over a year. However, its balance sheet shows it holds HK$301.2m in cash, so it actually has HK$277.2m net cash.

A Look At Hong Kong Johnson Holdings' Liabilities

We can see from the most recent balance sheet that Hong Kong Johnson Holdings had liabilities of HK$253.3m falling due within a year, and liabilities of HK$25.5m due beyond that. Offsetting these obligations, it had cash of HK$301.2m as well as receivables valued at HK$408.5m due within 12 months. So it actually has HK$430.9m more liquid assets than total liabilities.

This surplus liquidity suggests that Hong Kong Johnson Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Hong Kong Johnson Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Hong Kong Johnson Holdings if management cannot prevent a repeat of the 94% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hong Kong Johnson 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. Hong Kong Johnson 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, Hong Kong Johnson Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hong Kong Johnson Holdings has HK$277.2m in net cash and a strong balance sheet. And it impressed us with free cash flow of HK$95m, being 189% of its EBIT. So we don't think Hong Kong Johnson Holdings's use of debt is risky. 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. To that end, you should be aware of the 3 warning signs we've spotted with Hong Kong Johnson Holdings .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.