Cirtek Holdings (HKG:1433) Seems To Use Debt Quite Sensibly

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 Cirtek Holdings Limited (HKG:1433) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Cirtek Holdings

What Is Cirtek Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Cirtek Holdings had HK$17.4m of debt in June 2021, down from HK$23.0m, one year before. However, its balance sheet shows it holds HK$99.4m in cash, so it actually has HK$82.0m net cash.

How Strong Is Cirtek Holdings' Balance Sheet?

The latest balance sheet data shows that Cirtek Holdings had liabilities of HK$100.2m due within a year, and liabilities of HK$22.1m falling due after that. Offsetting this, it had HK$99.4m in cash and HK$35.7m in receivables that were due within 12 months. So it can boast HK$12.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Cirtek Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Cirtek Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Cirtek Holdings's load is not too heavy, because its EBIT was down 35% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Cirtek 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. Cirtek 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 most recent three years, Cirtek Holdings recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Cirtek Holdings has HK$82.0m in net cash and a decent-looking balance sheet. So we don't have any problem with Cirtek Holdings's use of debt. 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 3 warning signs we've spotted with Cirtek 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.

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.

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