We Think International Business Settlement Holdings (HKG:147) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that International Business Settlement Holdings Limited (HKG:147) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for International Business Settlement Holdings

What Is International Business Settlement Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that International Business Settlement Holdings had debt of HK$825.1m at the end of September 2023, a reduction from HK$863.8m over a year. However, it does have HK$331.9m in cash offsetting this, leading to net debt of about HK$493.1m.

A Look At International Business Settlement Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that International Business Settlement Holdings had liabilities of HK$1.61b due within 12 months and liabilities of HK$123.9m due beyond that. On the other hand, it had cash of HK$331.9m and HK$71.3m worth of receivables due within a year. So it has liabilities totalling HK$1.33b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's HK$1.30b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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).

While International Business Settlement Holdings has a quite reasonable net debt to EBITDA multiple of 1.8, its interest cover seems weak, at 2.0. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. Notably, International Business Settlement Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of HK$182m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is International Business Settlement 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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, International Business Settlement 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 International Business Settlement Holdings's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least its net debt to EBITDA is not so bad. We're quite clear that we consider International Business Settlement Holdings to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - International Business Settlement Holdings has 1 warning sign we think you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.