Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Asia Commercial Holdings Limited (HKG:104) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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 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, 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Asia Commercial Holdings's Debt?
You can click the graphic below for the historical numbers, but it shows that Asia Commercial Holdings had HK$93.0m of debt in September 2021, down from HK$163.2m, one year before. However, its balance sheet shows it holds HK$146.3m in cash, so it actually has HK$53.3m net cash.
How Strong Is Asia Commercial Holdings' Balance Sheet?
The latest balance sheet data shows that Asia Commercial Holdings had liabilities of HK$250.2m due within a year, and liabilities of HK$50.5m falling due after that. On the other hand, it had cash of HK$146.3m and HK$73.0m worth of receivables due within a year. So its liabilities total HK$81.4m more than the combination of its cash and short-term receivables.
Asia Commercial Holdings has a market capitalization of HK$212.9m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Asia Commercial Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, Asia Commercial Holdings grew its EBIT by 724% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Asia Commercial 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 company can only pay off debt with cold hard cash, not accounting profits. While Asia Commercial 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. Happily for any shareholders, Asia Commercial 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.
While Asia Commercial Holdings does have more liabilities than liquid assets, it also has net cash of HK$53.3m. And it impressed us with free cash flow of HK$134m, being 115% of its EBIT. So we don't think Asia Commercial Holdings's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Asia Commercial Holdings , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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.
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