F8 Enterprises (Holdings) Group (HKG:8347) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that F8 Enterprises (Holdings) Group Limited (HKG:8347) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for F8 Enterprises (Holdings) Group

What Is F8 Enterprises (Holdings) Group's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2021 F8 Enterprises (Holdings) Group had debt of HK$30.1m, up from HK$24.9m in one year. On the flip side, it has HK$21.3m in cash leading to net debt of about HK$8.78m.

A Look At F8 Enterprises (Holdings) Group's Liabilities

We can see from the most recent balance sheet that F8 Enterprises (Holdings) Group had liabilities of HK$82.0m falling due within a year, and liabilities of HK$561.0k due beyond that. On the other hand, it had cash of HK$21.3m and HK$86.7m worth of receivables due within a year. So it actually has HK$25.4m more liquid assets than total liabilities.

It's good to see that F8 Enterprises (Holdings) Group has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 0.67 and interest cover of 4.2 times, it seems to us that F8 Enterprises (Holdings) Group is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Notably, F8 Enterprises (Holdings) Group's EBIT launched higher than Elon Musk, gaining a whopping 134% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since F8 Enterprises (Holdings) Group will need earnings to service that debt. 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, F8 Enterprises (Holdings) Group saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

F8 Enterprises (Holdings) Group's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that F8 Enterprises (Holdings) Group takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example F8 Enterprises (Holdings) Group has 4 warning signs (and 1 which shouldn't be ignored) we think 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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