Is Asia Cassava Resources Holdings (HKG:841) A Risky Investment?

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.' 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. As with many other companies Asia Cassava Resources Holdings Limited (HKG:841) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

See our latest analysis for Asia Cassava Resources Holdings

What Is Asia Cassava Resources Holdings's Debt?

As you can see below, Asia Cassava Resources Holdings had HK$1.24b of debt at March 2023, down from HK$1.97b a year prior. However, it does have HK$271.5m in cash offsetting this, leading to net debt of about HK$965.6m.

How Healthy Is Asia Cassava Resources Holdings' Balance Sheet?

The latest balance sheet data shows that Asia Cassava Resources Holdings had liabilities of HK$679.3m due within a year, and liabilities of HK$699.9m falling due after that. On the other hand, it had cash of HK$271.5m and HK$209.3m worth of receivables due within a year. So it has liabilities totalling HK$898.4m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$117.5m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Asia Cassava Resources Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Asia Cassava Resources Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (32.4), and fairly weak interest coverage, since EBIT is just 0.43 times the interest expense. This means we'd consider it to have a heavy debt load. Worse, Asia Cassava Resources Holdings's EBIT was down 80% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Asia Cassava Resources Holdings 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Asia Cassava Resources Holdings 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.

Our View

On the face of it, Asia Cassava Resources Holdings's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its interest cover also fails to instill confidence. It looks to us like Asia Cassava Resources Holdings carries a significant balance sheet burden. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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. To that end, you should learn about the 3 warning signs we've spotted with Asia Cassava Resources Holdings (including 2 which are potentially serious) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.