Is Stella International Holdings (HKG:1836) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Stella International Holdings Limited (HKG:1836) does use debt in its business. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Stella International Holdings

What Is Stella International Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Stella International Holdings had debt of US$7.71m, up from US$2.89m in one year. However, it does have US$135.2m in cash offsetting this, leading to net cash of US$127.5m.

How Healthy Is Stella International Holdings' Balance Sheet?

The latest balance sheet data shows that Stella International Holdings had liabilities of US$257.6m due within a year, and liabilities of US$23.9m falling due after that. Offsetting these obligations, it had cash of US$135.2m as well as receivables valued at US$328.5m due within 12 months. So it actually has US$182.3m more liquid assets than total liabilities.

This excess liquidity suggests that Stella International Holdings is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Stella International Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Stella International Holdings grew its EBIT by 1,122% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Stella International Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Stella International 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, Stella International 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 Stella International Holdings has US$127.5m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$65m, being 155% of its EBIT. The bottom line is that we do not find Stella International Holdings's debt levels at all concerning. 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. We've identified 1 warning sign with Stella International Holdings , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.