These 4 Measures Indicate That Great Eagle Holdings (HKG:41) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Great Eagle Holdings Limited (HKG:41) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

View our latest analysis for Great Eagle Holdings

What Is Great Eagle Holdings's Net Debt?

The chart below, which you can click on for greater detail, shows that Great Eagle Holdings had HK$33.5b in debt in June 2023; about the same as the year before. However, it does have HK$7.87b in cash offsetting this, leading to net debt of about HK$25.6b.

A Look At Great Eagle Holdings' Liabilities

The latest balance sheet data shows that Great Eagle Holdings had liabilities of HK$26.3b due within a year, and liabilities of HK$14.8b falling due after that. Offsetting these obligations, it had cash of HK$7.87b as well as receivables valued at HK$876.4m due within 12 months. So it has liabilities totalling HK$32.4b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the HK$8.88b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Great Eagle Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

Great Eagle Holdings has a rather high debt to EBITDA ratio of 6.9 which suggests a meaningful debt load. However, its interest coverage of 3.6 is reasonably strong, which is a good sign. The good news is that Great Eagle Holdings grew its EBIT a smooth 40% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Great Eagle Holdings will need earnings to service that debt. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Great Eagle Holdings recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

While Great Eagle Holdings's level of total liabilities has us nervous. For example, its EBIT growth rate and conversion of EBIT to free cash flow give us some confidence in its ability to manage its debt. When we consider all the factors discussed, it seems to us that Great Eagle Holdings is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Great Eagle Holdings (including 1 which makes us a bit uncomfortable) .

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.