Is AM Group Holdings (HKG:1849) A Risky Investment?

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. We note that AM Group Holdings Limited (HKG:1849) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for AM Group Holdings

How Much Debt Does AM Group Holdings Carry?

The image below, which you can click on for greater detail, shows that at December 2022 AM Group Holdings had debt of S$3.26m, up from S$1.92m in one year. However, it does have S$28.1m in cash offsetting this, leading to net cash of S$24.8m.

How Healthy Is AM Group Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that AM Group Holdings had liabilities of S$29.6m due within 12 months and liabilities of S$2.62m due beyond that. Offsetting this, it had S$28.1m in cash and S$27.6m in receivables that were due within 12 months. So it can boast S$23.5m more liquid assets than total liabilities.

This surplus liquidity suggests that AM Group Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, AM Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that AM Group Holdings's EBIT was down 97% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is AM Group Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. AM Group Holdings 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. During the last two years, AM Group Holdings produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case AM Group Holdings has S$24.8m in net cash and a decent-looking balance sheet. So we are not troubled with AM Group Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for AM Group Holdings you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.