Winfair Investment (HKG:287) Could Easily Take On More Debt

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.' 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 Winfair Investment Company Limited (HKG:287) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Winfair Investment

What Is Winfair Investment's Net Debt?

The image below, which you can click on for greater detail, shows that Winfair Investment had debt of HK$19.1m at the end of September 2020, a reduction from HK$19.9m over a year. But on the other hand it also has HK$211.1m in cash, leading to a HK$191.9m net cash position.

How Healthy Is Winfair Investment's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Winfair Investment had liabilities of HK$29.8m due within 12 months and liabilities of HK$1.02m due beyond that. On the other hand, it had cash of HK$211.1m and HK$435.0k worth of receivables due within a year. So it actually has HK$180.7m more liquid assets than total liabilities.

This luscious liquidity implies that Winfair Investment's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Winfair Investment has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Winfair Investment grew its EBIT by 62% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Winfair Investment'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 Winfair Investment 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, Winfair Investment produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Winfair Investment has net cash of HK$191.9m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 62% over the last year. At the end of the day we're not concerned about Winfair Investment's debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Winfair Investment is showing 4 warning signs in our investment analysis , and 1 of those is significant...

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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