Stock Analysis

Human Health Holdings (HKG:1419) Seems To Use Debt Quite Sensibly

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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.' 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. We note that Human Health Holdings Limited (HKG:1419) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

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What Is Human Health Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Human Health Holdings had debt of HK$45.1m, up from HK$13.6m in one year. However, its balance sheet shows it holds HK$301.4m in cash, so it actually has HK$256.3m net cash.

SEHK:1419 Debt to Equity History March 21st 2022

How Healthy Is Human Health Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Human Health Holdings had liabilities of HK$228.4m due within 12 months and liabilities of HK$17.7m due beyond that. Offsetting this, it had HK$301.4m in cash and HK$90.0m in receivables that were due within 12 months. So it actually has HK$145.2m more liquid assets than total liabilities.

It's good to see that Human Health Holdings has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Human Health Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Human Health Holdings turned things around in the last 12 months, delivering and EBIT of HK$257m. There's no doubt that we learn most about debt from the balance sheet. But it is Human Health 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. While Human Health Holdings 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. Looking at the most recent year, Human Health Holdings recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Human Health Holdings has net cash of HK$256.3m, as well as more liquid assets than liabilities. So we don't think Human Health Holdings's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Human Health Holdings that you should be aware of before investing here.

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.

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