Is San Miguel Brewery Hong Kong (HKG:236) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies San Miguel Brewery Hong Kong Limited (HKG:236) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out the opportunities and risks within the HK Beverage industry.

What Is San Miguel Brewery Hong Kong's Debt?

The image below, which you can click on for greater detail, shows that San Miguel Brewery Hong Kong had debt of HK$16.7m at the end of June 2022, a reduction from HK$67.6m over a year. However, its balance sheet shows it holds HK$92.5m in cash, so it actually has HK$75.9m net cash.

How Healthy Is San Miguel Brewery Hong Kong's Balance Sheet?

According to the last reported balance sheet, San Miguel Brewery Hong Kong had liabilities of HK$117.8m due within 12 months, and liabilities of HK$6.10m due beyond 12 months. On the other hand, it had cash of HK$92.5m and HK$77.1m worth of receivables due within a year. So it actually has HK$45.7m more liquid assets than total liabilities.

This surplus suggests that San Miguel Brewery Hong Kong is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, San Miguel Brewery Hong Kong boasts net cash, so it's fair to say it does not have a heavy debt load!

Although San Miguel Brewery Hong Kong made a loss at the EBIT level, last year, it was also good to see that it generated HK$25m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since San Miguel Brewery Hong Kong will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While San Miguel Brewery Hong Kong 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 year, San Miguel Brewery Hong Kong burned a lot of cash. 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.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that San Miguel Brewery Hong Kong has net cash of HK$75.9m, as well as more liquid assets than liabilities. So we are not troubled with San Miguel Brewery Hong Kong's debt use. 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. We've identified 1 warning sign with San Miguel Brewery Hong Kong , and understanding them should be part of your investment process.

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.