Is Asia Cassava Resources Holdings (HKG:841) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Asia Cassava Resources Holdings Limited (HKG:841) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Asia Cassava Resources Holdings

What Is Asia Cassava Resources Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Asia Cassava Resources Holdings had HK$954.3m of debt, an increase on HK$890.8m, over one year. However, it does have HK$205.6m in cash offsetting this, leading to net debt of about HK$748.7m.

How Strong Is Asia Cassava Resources Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Asia Cassava Resources Holdings had liabilities of HK$751.6m due within 12 months and liabilities of HK$288.8m due beyond that. Offsetting this, it had HK$205.6m in cash and HK$112.3m in receivables that were due within 12 months. So its liabilities total HK$722.5m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$193.0m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Asia Cassava Resources Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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 (17.9), and fairly weak interest coverage, since EBIT is just 2.2 times the interest expense. The debt burden here is substantial. One redeeming factor for Asia Cassava Resources Holdings is that it turned last year's EBIT loss into a gain of HK$37m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Asia Cassava Resources Holdings'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Asia Cassava Resources Holdings barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

To be frank both Asia Cassava Resources Holdings's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. After considering the datapoints discussed, we think Asia Cassava Resources Holdings has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Asia Cassava Resources Holdings (at least 2 which are concerning) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

If you decide to trade Asia Cassava Resources Holdings, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all 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 (at) simplywallst.com.