Is Asia Commercial Holdings (HKG:104) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Commercial Holdings Limited (HKG:104) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Asia Commercial Holdings

How Much Debt Does Asia Commercial Holdings Carry?

The chart below, which you can click on for greater detail, shows that Asia Commercial Holdings had HK$164.1m in debt in March 2021; about the same as the year before. However, it also had HK$155.8m in cash, and so its net debt is HK$8.30m.

A Look At Asia Commercial Holdings' Liabilities

We can see from the most recent balance sheet that Asia Commercial Holdings had liabilities of HK$349.4m falling due within a year, and liabilities of HK$56.6m due beyond that. Offsetting these obligations, it had cash of HK$155.8m as well as receivables valued at HK$102.7m due within 12 months. So its liabilities total HK$147.5m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of HK$194.3m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Asia Commercial Holdings's debt of just 0.09 times EBITDA is really very modest. And EBIT easily covered the interest expense 9.6 times over, lending force to that view. Better yet, Asia Commercial Holdings grew its EBIT by 1,622% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Asia Commercial 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Asia Commercial Holdings's free cash flow amounted to 49% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Asia Commercial Holdings's impressive EBIT growth rate implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. All these things considered, it appears that Asia Commercial Holdings can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Asia Commercial Holdings 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.

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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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