These 4 Measures Indicate That AUX International Holdings (HKG:2080) Is Using Debt Safely

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 AUX International Holdings Limited (HKG:2080) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for AUX International Holdings

How Much Debt Does AUX International Holdings Carry?

As you can see below, at the end of March 2022, AUX International Holdings had HK$110.9m of debt, up from HK$85.3m a year ago. Click the image for more detail. However, it does have HK$350.2m in cash offsetting this, leading to net cash of HK$239.4m.

A Look At AUX International Holdings' Liabilities

We can see from the most recent balance sheet that AUX International Holdings had liabilities of HK$318.8m falling due within a year, and liabilities of HK$39.6m due beyond that. Offsetting this, it had HK$350.2m in cash and HK$75.9m in receivables that were due within 12 months. So it actually has HK$67.7m more liquid assets than total liabilities.

This excess liquidity suggests that AUX International Holdings is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that AUX International Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that AUX International Holdings grew its EBIT by 13% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since AUX International Holdings 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, a company can only pay off debt with cold hard cash, not accounting profits. AUX International 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, AUX International Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case AUX International Holdings has HK$239.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$43m, being 167% of its EBIT. So we don't think AUX International Holdings's use of debt is risky. 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. For example - AUX International Holdings has 3 warning signs we think 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.