Oriental Watch Holdings (HKG:398) Could Easily Take On More Debt

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. As with many other companies Oriental Watch Holdings Limited (HKG:398) 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 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.

See our latest analysis for Oriental Watch Holdings

What Is Oriental Watch Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Oriental Watch Holdings had debt of HK$17.5m, up from HK$5.67m in one year. But on the other hand it also has HK$1.07b in cash, leading to a HK$1.05b net cash position.

How Healthy Is Oriental Watch Holdings' Balance Sheet?

The latest balance sheet data shows that Oriental Watch Holdings had liabilities of HK$452.5m due within a year, and liabilities of HK$284.5m falling due after that. Offsetting these obligations, it had cash of HK$1.07b as well as receivables valued at HK$287.6m due within 12 months. So it actually has HK$617.9m more liquid assets than total liabilities.

This excess liquidity is a great indication that Oriental Watch Holdings' balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Oriental Watch Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Oriental Watch Holdings grew its EBIT by 103% over twelve months. 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 it is Oriental Watch 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Oriental Watch 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. Over the last three years, Oriental Watch Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Oriental Watch Holdings has net cash of HK$1.05b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of HK$614m, being 185% of its EBIT. At the end of the day we're not concerned about Oriental Watch Holdings'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. For example - Oriental Watch Holdings has 2 warning signs we think you should be aware of.

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.

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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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