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. As with many other companies San Miguel Brewery Hong Kong Limited (HKG:236) makes use of debt. But is this debt a concern to shareholders?
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. 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. 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.
How Much Debt Does San Miguel Brewery Hong Kong Carry?
The image below, which you can click on for greater detail, shows that San Miguel Brewery Hong Kong had debt of HK$102.6m at the end of June 2019, a reduction from HK$141.6m over a year. However, its balance sheet shows it holds HK$121.2m in cash, so it actually has HK$18.6m net cash.
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$127.9m due within 12 months and liabilities of HK$100.7m due beyond that. On the other hand, it had cash of HK$121.2m and HK$64.8m worth of receivables due within a year. So it has liabilities totalling HK$42.6m more than its cash and near-term receivables, combined.
Given San Miguel Brewery Hong Kong has a market capitalization of HK$381.0m, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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!
Importantly, San Miguel Brewery Hong Kong’s EBIT fell a jaw-dropping 46% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. 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.
Although San Miguel Brewery Hong Kong’s balance sheet isn’t particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$18.6m. The cherry on top was that in converted 176% of that EBIT to free cash flow, bringing in HK$18m. So we don’t have any problem with San Miguel Brewery Hong Kong’s use of debt. While San Miguel Brewery Hong Kong didn’t make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.