Here's Why Hans Energy (HKG:554) Can Afford Some 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Hans Energy Company Limited (HKG:554) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Hans Energy

How Much Debt Does Hans Energy Carry?

As you can see below, at the end of December 2020, Hans Energy had HK$789.8m of debt, up from HK$702.5m a year ago. Click the image for more detail. However, because it has a cash reserve of HK$353.2m, its net debt is less, at about HK$436.6m.

How Strong Is Hans Energy's Balance Sheet?

The latest balance sheet data shows that Hans Energy had liabilities of HK$379.4m due within a year, and liabilities of HK$654.9m falling due after that. Offsetting these obligations, it had cash of HK$353.2m as well as receivables valued at HK$80.1m due within 12 months. So its liabilities total HK$600.9m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Hans Energy is worth HK$1.33b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hans Energy'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.

In the last year Hans Energy wasn't profitable at an EBIT level, but managed to grow its revenue by 675%, to HK$2.5b. When it comes to revenue growth, that's like nailing the game winning 3-pointer!

Caveat Emptor

While we can certainly appreciate Hans Energy's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at HK$6.3m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of HK$40m. So we do think this stock is quite risky. 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. We've identified 2 warning signs with Hans Energy (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

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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