These 4 Measures Indicate That Asia Cassava Resources Holdings (HKG:841) Is Using Debt Extensively

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.' 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 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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Net Debt?

As you can see below, at the end of September 2022, Asia Cassava Resources Holdings had HK$1.18b of debt, up from HK$1.09b a year ago. Click the image for more detail. However, it does have HK$126.1m in cash offsetting this, leading to net debt of about HK$1.05b.

How Healthy 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$572.9m due within 12 months and liabilities of HK$714.1m due beyond that. Offsetting this, it had HK$126.1m in cash and HK$221.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$939.9m.

The deficiency here weighs heavily on the HK$201.7m 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 definitely think shareholders need to watch this one closely. After all, Asia Cassava Resources Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

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 has a rather high debt to EBITDA ratio of 8.7 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 6.1 times, suggesting it can responsibly service its obligations. Importantly, Asia Cassava Resources Holdings grew its EBIT by 91% over the last twelve months, and that growth will make it easier to handle its debt. 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, 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 that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Asia Cassava Resources Holdings's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. We're quite clear that we consider Asia Cassava Resources Holdings to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Case in point: We've spotted 4 warning signs for Asia Cassava Resources Holdings you should be aware of, and 2 of them are potentially serious.

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.

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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.