We Think Be Friends Holding (HKG:1450) Can Stay On Top Of Its Debt

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 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. We can see that Be Friends Holding Limited (HKG:1450) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Be Friends Holding

How Much Debt Does Be Friends Holding Carry?

You can click the graphic below for the historical numbers, but it shows that Be Friends Holding had CN¥131.1m of debt in June 2023, down from CN¥148.1m, one year before. On the flip side, it has CN¥70.4m in cash leading to net debt of about CN¥60.7m.

How Strong Is Be Friends Holding's Balance Sheet?

According to the last reported balance sheet, Be Friends Holding had liabilities of CN¥364.5m due within 12 months, and liabilities of CN¥28.3m due beyond 12 months. Offsetting this, it had CN¥70.4m in cash and CN¥203.8m in receivables that were due within 12 months. So its liabilities total CN¥118.6m more than the combination of its cash and short-term receivables.

Given Be Friends Holding has a market capitalization of CN¥1.77b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 0.69 and interest cover of 6.9 times, it seems to us that Be Friends Holding is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. It was also good to see that despite losing money on the EBIT line last year, Be Friends Holding turned things around in the last 12 months, delivering and EBIT of CN¥83m. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Be Friends Holding 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Be Friends Holding generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Be Friends Holding's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Taking all this data into account, it seems to us that Be Friends Holding takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. Case in point: We've spotted 2 warning signs for Be Friends Holding you should be aware of.

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.