Is HM International Holdings (HKG:8416) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies HM International Holdings Limited (HKG:8416) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for HM International Holdings

What Is HM International Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2021 HM International Holdings had debt of HK$14.4m, up from none in one year. However, its balance sheet shows it holds HK$50.1m in cash, so it actually has HK$35.7m net cash.

How Healthy Is HM International Holdings' Balance Sheet?

We can see from the most recent balance sheet that HM International Holdings had liabilities of HK$50.5m falling due within a year, and liabilities of HK$818.0k due beyond that. On the other hand, it had cash of HK$50.1m and HK$52.6m worth of receivables due within a year. So it actually has HK$51.3m more liquid assets than total liabilities.

This surplus liquidity suggests that HM International Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, HM International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

We also note that HM International Holdings improved its EBIT from a last year's loss to a positive HK$2.9m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since HM International 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, a company can only pay off debt with cold hard cash, not accounting profits. HM International 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 year, HM International Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that HM International Holdings has net cash of HK$35.7m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of HK$18m, being 619% of its EBIT. So is HM International Holdings's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with HM International Holdings (including 2 which can't be ignored) .

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.

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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.