These 4 Measures Indicate That Hypebeast (HKG:150) Is Using Debt Reasonably Well

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.' 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 can see that Hypebeast Limited (HKG:150) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hypebeast

How Much Debt Does Hypebeast Carry?

You can click the graphic below for the historical numbers, but it shows that Hypebeast had HK$13.6m of debt in September 2020, down from HK$28.3m, one year before. But on the other hand it also has HK$144.2m in cash, leading to a HK$130.7m net cash position.

A Look At Hypebeast's Liabilities

We can see from the most recent balance sheet that Hypebeast had liabilities of HK$135.4m falling due within a year, and liabilities of HK$70.9m due beyond that. Offsetting these obligations, it had cash of HK$144.2m as well as receivables valued at HK$154.8m due within 12 months. So it actually has HK$92.7m more liquid assets than total liabilities.

This surplus suggests that Hypebeast has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Hypebeast has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Hypebeast has seen its EBIT plunge 16% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Hypebeast 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hypebeast may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Hypebeast recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Hypebeast has net cash of HK$130.7m, as well as more liquid assets than liabilities. So we don't have any problem with Hypebeast's use of debt. 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. For example, we've discovered 1 warning sign for Hypebeast that you should be aware of before investing here.

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.

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