These 4 Measures Indicate That Eco-Tek Holdings (HKG:8169) Is Using Debt Safely

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 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, Eco-Tek Holdings Limited (HKG:8169) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Eco-Tek Holdings

What Is Eco-Tek Holdings's Net Debt?

As you can see below, at the end of April 2021, Eco-Tek Holdings had HK$13.9m of debt, up from HK$9.50m a year ago. Click the image for more detail. However, it does have HK$58.3m in cash offsetting this, leading to net cash of HK$44.4m.

A Look At Eco-Tek Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Eco-Tek Holdings had liabilities of HK$70.5m due within 12 months and liabilities of HK$12.7m due beyond that. Offsetting these obligations, it had cash of HK$58.3m as well as receivables valued at HK$22.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$1.97m.

Given Eco-Tek Holdings has a market capitalization of HK$40.9m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Eco-Tek Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Eco-Tek Holdings grew its EBIT by 1,567% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Eco-Tek Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Eco-Tek 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. Happily for any shareholders, Eco-Tek Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Eco-Tek Holdings has HK$44.4m in net cash. And it impressed us with free cash flow of HK$20m, being 108% of its EBIT. So we don't think Eco-Tek 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 learn about the 2 warning signs we've spotted with Eco-Tek Holdings (including 1 which doesn'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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