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. 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. As with many other companies Hopefluent Group Holdings Limited (HKG:733) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Hopefluent Group Holdings's Debt?
As you can see below, Hopefluent Group Holdings had HK$516.3m of debt at December 2019, down from HK$690.6m a year prior. But on the other hand it also has HK$2.46b in cash, leading to a HK$1.95b net cash position.
A Look At Hopefluent Group Holdings's Liabilities
Zooming in on the latest balance sheet data, we can see that Hopefluent Group Holdings had liabilities of HK$1.79b due within 12 months and liabilities of HK$217.4m due beyond that. On the other hand, it had cash of HK$2.46b and HK$2.22b worth of receivables due within a year. So it can boast HK$2.68b more liquid assets than total liabilities.
This surplus liquidity suggests that Hopefluent Group Holdings's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Succinctly put, Hopefluent Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Hopefluent Group Holdings grew its EBIT at 14% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hopefluent Group Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hopefluent Group 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. Over the last three years, Hopefluent Group Holdings reported free cash flow worth 19% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
While it is always sensible to investigate a company's debt, in this case Hopefluent Group Holdings has HK$1.95b in net cash and a strong balance sheet. On top of that, it increased its EBIT by 14% in the last twelve months. So is Hopefluent Group Holdings's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 2 warning signs for Hopefluent Group Holdings that you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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