Tristate Holdings (HKG:458) Seems To Use Debt Quite Sensibly

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.' 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. Importantly, Tristate Holdings Limited (HKG:458) does carry debt. 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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Tristate Holdings

What Is Tristate Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Tristate Holdings had HK$177.0m of debt, an increase on HK$50.6m, over one year. But on the other hand it also has HK$313.6m in cash, leading to a HK$136.6m net cash position.

How Strong Is Tristate Holdings' Balance Sheet?

According to the last reported balance sheet, Tristate Holdings had liabilities of HK$1.12b due within 12 months, and liabilities of HK$807.1m due beyond 12 months. Offsetting these obligations, it had cash of HK$313.6m as well as receivables valued at HK$387.3m due within 12 months. So its liabilities total HK$1.22b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$192.8m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Tristate Holdings would likely require a major re-capitalisation if it had to pay its creditors today. Given that Tristate Holdings has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Notably, Tristate Holdings's EBIT launched higher than Elon Musk, gaining a whopping 844% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tristate 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, a company can only pay off debt with cold hard cash, not accounting profits. Tristate 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 two years, Tristate 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 Tristate Holdings does have more liabilities than liquid assets, it also has net cash of HK$136.6m. And it impressed us with free cash flow of HK$149m, being 116% of its EBIT. So we don't have any problem with Tristate Holdings's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Tristate Holdings has 2 warning signs we think you should be aware of.

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.