Wine's Link International Holdings (HKG:8509) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, '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, Wine's Link International Holdings Limited (HKG:8509) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Wine's Link International Holdings

How Much Debt Does Wine's Link International Holdings Carry?

The image below, which you can click on for greater detail, shows that at March 2023 Wine's Link International Holdings had debt of HK$140.9m, up from HK$128.3m in one year. On the flip side, it has HK$5.75m in cash leading to net debt of about HK$135.1m.

How Healthy Is Wine's Link International Holdings' Balance Sheet?

We can see from the most recent balance sheet that Wine's Link International Holdings had liabilities of HK$166.5m falling due within a year, and liabilities of HK$1.51m due beyond that. Offsetting this, it had HK$5.75m in cash and HK$45.3m in receivables that were due within 12 months. So its liabilities total HK$117.0m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of HK$168.0m, so it does suggest shareholders should keep an eye on Wine's Link International Holdings' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Wine's Link International Holdings's debt is 4.5 times its EBITDA, and its EBIT cover its interest expense 4.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. We saw Wine's Link International Holdings grow its EBIT by 2.2% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Wine's Link International Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Wine's Link International Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On our analysis Wine's Link International Holdings's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. To be specific, it seems about as good at managing its debt, based on its EBITDA, as wet socks are at keeping your feet warm. Looking at all this data makes us feel a little cautious about Wine's Link International Holdings's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with Wine's Link International Holdings (at least 1 which shouldn't be ignored) , 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.

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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.