Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Wing On Company International Limited (HKG:289) does use debt in its business. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Wing On Company International's Debt?
You can click the graphic below for the historical numbers, but it shows that Wing On Company International had HK$74.9m of debt in December 2020, down from HK$103.3m, one year before. But on the other hand it also has HK$4.09b in cash, leading to a HK$4.01b net cash position.
How Healthy Is Wing On Company International's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Wing On Company International had liabilities of HK$445.6m due within 12 months and liabilities of HK$1.00b due beyond that. Offsetting this, it had HK$4.09b in cash and HK$49.9m in receivables that were due within 12 months. So it actually has HK$2.69b more liquid assets than total liabilities.
This luscious liquidity implies that Wing On Company International'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. Succinctly put, Wing On Company International boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Wing On Company International's EBIT dived 13%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Wing On Company International will need earnings to service that debt. 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. Wing On Company International 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. In the last three years, Wing On Company International's free cash flow amounted to 39% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Wing On Company International has net cash of HK$4.01b, as well as more liquid assets than liabilities. So is Wing On Company International's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Wing On Company International has 2 warning signs (and 1 which is concerning) we think you should know about.
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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