We Think Nameson Holdings (HKG:1982) Can Stay On Top Of Its 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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Nameson Holdings Limited (HKG:1982) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Nameson Holdings

What Is Nameson Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Nameson Holdings had HK$1.32b of debt in September 2021, down from HK$1.50b, one year before. However, because it has a cash reserve of HK$569.0m, its net debt is less, at about HK$750.8m.

How Strong Is Nameson Holdings' Balance Sheet?

We can see from the most recent balance sheet that Nameson Holdings had liabilities of HK$1.50b falling due within a year, and liabilities of HK$890.1m due beyond that. On the other hand, it had cash of HK$569.0m and HK$600.7m worth of receivables due within a year. So its liabilities total HK$1.22b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of HK$945.9m, we think shareholders really should watch Nameson Holdings's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Nameson Holdings's net debt to EBITDA ratio of about 1.7 suggests only moderate use of debt. And its strong interest cover of 13.2 times, makes us even more comfortable. In addition to that, we're happy to report that Nameson Holdings has boosted its EBIT by 31%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Nameson 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Nameson Holdings produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Both Nameson Holdings's ability to to cover its interest expense with its EBIT and its EBIT growth rate gave us comfort that it can handle its debt. But truth be told its level of total liabilities had us nibbling our nails. When we consider all the factors mentioned above, we do feel a bit cautious about Nameson Holdings's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Nameson Holdings (of which 1 is a bit unpleasant!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.