Allan International Holdings (HKG:684) Could Easily Take On More 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.' 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. As with many other companies Allan International Holdings Limited (HKG:684) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Allan International Holdings

What Is Allan International Holdings's Debt?

As you can see below, Allan International Holdings had HK$28.6m of debt at September 2020, down from HK$33.7m a year prior. However, it does have HK$730.1m in cash offsetting this, leading to net cash of HK$701.5m.

How Strong Is Allan International Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Allan International Holdings had liabilities of HK$350.7m due within 12 months and liabilities of HK$60.5m due beyond that. Offsetting these obligations, it had cash of HK$730.1m as well as receivables valued at HK$224.4m due within 12 months. So it actually has HK$543.3m more liquid assets than total liabilities.

This surplus liquidity suggests that Allan International Holdings's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, Allan International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Allan International Holdings grew its EBIT by 45% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Allan International Holdings's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Allan 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 two years, Allan 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 it is always sensible to investigate a company's debt, in this case Allan International Holdings has HK$701.5m in net cash and a strong balance sheet. The cherry on top was that in converted 287% of that EBIT to free cash flow, bringing in HK$105m. At the end of the day we're not concerned about Allan International Holdings's 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. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Allan International Holdings (of which 1 is a bit concerning!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. 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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