Does Allan International Holdings (HKG:684) Have A Healthy Balance Sheet?

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 Allan International Holdings Limited (HKG:684) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. 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.

View our latest analysis for Allan International Holdings

How Much Debt Does Allan International Holdings Carry?

The image below, which you can click on for greater detail, shows that Allan International Holdings had debt of HK$28.6m at the end of September 2020, a reduction from HK$33.7m over a year. But on the other hand it also has HK$730.1m in cash, leading to a HK$701.5m net cash position.

How Healthy Is Allan International Holdings' Balance Sheet?

We can see from the most recent balance sheet that Allan International Holdings had liabilities of HK$350.7m falling due within a year, and liabilities of HK$60.5m due beyond that. On the other hand, it had cash of HK$730.1m and HK$224.4m worth of receivables due within a year. So it can boast HK$543.3m more liquid assets than total liabilities.

This surplus liquidity suggests that Allan International Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Allan International Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

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. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Allan International Holdings will need earnings to service that debt. 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. 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. Happily for any shareholders, Allan International Holdings actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, the bottom line is that Allan International Holdings has net cash of HK$701.5m and plenty of liquid assets. And it impressed us with free cash flow of HK$104m, being 282% of its EBIT. The bottom line is that Allan International Holdings's use of debt is absolutely fine. 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. To that end, you should learn about the 3 warning signs we've spotted with Allan International Holdings (including 1 which is potentially serious) .

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.

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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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