We Think F8 Enterprises (Holdings) Group (HKG:8347) Can Stay On Top Of Its Debt

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.' 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. We can see that F8 Enterprises (Holdings) Group Limited (HKG:8347) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for F8 Enterprises (Holdings) Group

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

As you can see below, at the end of September 2020, F8 Enterprises (Holdings) Group had HK$31.6m of debt, up from HK$24.7m a year ago. Click the image for more detail. On the flip side, it has HK$11.5m in cash leading to net debt of about HK$20.1m.

How Strong Is F8 Enterprises (Holdings) Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that F8 Enterprises (Holdings) Group had liabilities of HK$65.1m due within 12 months and liabilities of HK$9.50m due beyond that. Offsetting this, it had HK$11.5m in cash and HK$89.6m in receivables that were due within 12 months. So it can boast HK$26.5m more liquid assets than total liabilities.

This short term liquidity is a sign that F8 Enterprises (Holdings) Group could probably pay off its debt with ease, as its balance sheet is far from stretched.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

F8 Enterprises (Holdings) Group's net debt is sitting at a very reasonable 1.9 times its EBITDA, while its EBIT covered its interest expense just 4.9 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. If F8 Enterprises (Holdings) Group can keep growing EBIT at last year's rate of 12% over the last year, then it will find its debt load easier to manage. There's no doubt that we learn most about debt from the balance sheet. But it is F8 Enterprises (Holdings) Group'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, F8 Enterprises (Holdings) Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

F8 Enterprises (Holdings) Group's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that it has an adequate capacity to handle its total liabilities. Looking at all this data makes us feel a little cautious about F8 Enterprises (Holdings) Group's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 5 warning signs for F8 Enterprises (Holdings) Group you should be aware of, and 1 of them is a bit concerning.

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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