San Miguel Brewery Hong Kong (HKG:236) Could Easily Take On More Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies San Miguel Brewery Hong Kong Limited (HKG:236) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for San Miguel Brewery Hong Kong

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$88.5m at the end of June 2020, a reduction from HK$102.6m over a year. But on the other hand it also has HK$120.8m in cash, leading to a HK$32.3m net cash position.

A Look At San Miguel Brewery Hong Kong's Liabilities

Zooming in on the latest balance sheet data, we can see that San Miguel Brewery Hong Kong had liabilities of HK$112.8m due within 12 months and liabilities of HK$75.3m due beyond that. On the other hand, it had cash of HK$120.8m and HK$65.3m worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

Having regard to San Miguel Brewery Hong Kong's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the HK$306.3m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, San Miguel Brewery Hong Kong boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, San Miguel Brewery Hong Kong grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. San Miguel Brewery Hong Kong may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, San Miguel Brewery Hong Kong actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that San Miguel Brewery Hong Kong has HK$32.3m in net cash. And it impressed us with free cash flow of HK$9.4m, being 144% of its EBIT. So we don't think San Miguel Brewery Hong Kong's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with San Miguel Brewery Hong Kong .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

When trading San Miguel Brewery Hong Kong or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.