Is Honma Golf (HKG:6858) Using Too Much Debt?

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.' 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 Honma Golf Limited (HKG:6858) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Honma Golf

What Is Honma Golf's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Honma Golf had JP¥8.03b of debt in March 2021, down from JP¥8.60b, one year before. But on the other hand it also has JP¥10.8b in cash, leading to a JP¥2.75b net cash position.

How Healthy Is Honma Golf's Balance Sheet?

The latest balance sheet data shows that Honma Golf had liabilities of JP¥12.8b due within a year, and liabilities of JP¥2.36b falling due after that. On the other hand, it had cash of JP¥10.8b and JP¥5.59b worth of receivables due within a year. So it actually has JP¥1.19b more liquid assets than total liabilities.

This short term liquidity is a sign that Honma Golf could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Honma Golf has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Honma Golf has been able to increase its EBIT by 22% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Honma Golf'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 Honma Golf 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. During the last three years, Honma Golf produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Honma Golf has net cash of JP¥2.75b, as well as more liquid assets than liabilities. And we liked the look of last year's 22% year-on-year EBIT growth. So we don't think Honma Golf's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Honma Golf you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.
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