Here's Why Asia Orient Holdings (HKG:214) Has A Meaningful Debt Burden

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Asia Orient Holdings Limited (HKG:214) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Asia Orient Holdings

How Much Debt Does Asia Orient Holdings Carry?

As you can see below, at the end of September 2020, Asia Orient Holdings had HK$18.6b of debt, up from HK$16.6b a year ago. Click the image for more detail. However, it does have HK$19.3b in cash offsetting this, leading to net cash of HK$658.2m.

A Look At Asia Orient Holdings's Liabilities

The latest balance sheet data shows that Asia Orient Holdings had liabilities of HK$8.92b due within a year, and liabilities of HK$12.1b falling due after that. Offsetting these obligations, it had cash of HK$19.3b as well as receivables valued at HK$1.11b due within 12 months. So it has liabilities totalling HK$610.8m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of HK$765.2m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Asia Orient Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

If Asia Orient Holdings can keep growing EBIT at last year's rate of 10% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But it is Asia Orient 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Asia Orient Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Asia Orient Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

Although Asia Orient Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$658.2m. On top of that, it increased its EBIT by 10% in the last twelve months. Despite the cash, we do find Asia Orient Holdings's conversion of EBIT to free cash flow concerning, so we're not particularly comfortable with the stock. 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. Take risks, for example - Asia Orient Holdings has 4 warning signs (and 2 which are significant) we think you should know about.

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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This article by Simply Wall St is general in nature. 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.
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