Midland Holdings (HKG:1200) Has A Pretty Healthy Balance Sheet

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. Importantly, Midland Holdings Limited (HKG:1200) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Midland Holdings

What Is Midland Holdings's Debt?

The image below, which you can click on for greater detail, shows that Midland Holdings had debt of HK$228.0m at the end of December 2020, a reduction from HK$489.0m over a year. But on the other hand it also has HK$940.6m in cash, leading to a HK$712.6m net cash position.

How Healthy Is Midland Holdings' Balance Sheet?

We can see from the most recent balance sheet that Midland Holdings had liabilities of HK$3.72b falling due within a year, and liabilities of HK$217.8m due beyond that. Offsetting this, it had HK$940.6m in cash and HK$3.26b in receivables that were due within 12 months. So it can boast HK$260.2m more liquid assets than total liabilities.

It's good to see that Midland Holdings has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Midland Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Notably, Midland Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of HK$45m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Midland Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Midland 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. Happily for any shareholders, Midland Holdings actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case Midland Holdings has HK$712.6m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 1,348% of that EBIT to free cash flow, bringing in HK$606m. So we don't think Midland Holdings's use of debt is risky. 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 instance, we've identified 3 warning signs for Midland Holdings (1 is significant) you should be aware of.

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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