Here's Why Fameglow Holdings (HKG:8603) Can Manage Its Debt Responsibly

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, Fameglow Holdings Limited (HKG:8603) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Fameglow Holdings

What Is Fameglow Holdings's Debt?

The chart below, which you can click on for greater detail, shows that Fameglow Holdings had HK$14.4m in debt in March 2023; about the same as the year before. However, its balance sheet shows it holds HK$27.9m in cash, so it actually has HK$13.5m net cash.

A Look At Fameglow Holdings' Liabilities

According to the last reported balance sheet, Fameglow Holdings had liabilities of HK$152.1m due within 12 months, and liabilities of HK$36.5m due beyond 12 months. On the other hand, it had cash of HK$27.9m and HK$8.54m worth of receivables due within a year. So it has liabilities totalling HK$152.2m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Fameglow Holdings is worth HK$392.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Fameglow Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Notably, Fameglow Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of HK$17m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Fameglow 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Fameglow Holdings 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. Over the last year, Fameglow 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 Fameglow Holdings does have more liabilities than liquid assets, it also has net cash of HK$13.5m. The cherry on top was that in converted 240% of that EBIT to free cash flow, bringing in HK$42m. So we don't have any problem with Fameglow Holdings's use of debt. 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. For example, we've discovered 2 warning signs for Fameglow Holdings (1 is a bit concerning!) that you should be aware of before investing here.

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. 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.