These 4 Measures Indicate That Emperor Watch & Jewellery (HKG:887) Is Using Debt Safely

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 Emperor Watch & Jewellery Limited (HKG:887) makes use of debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Emperor Watch & Jewellery

What Is Emperor Watch & Jewellery's Net Debt?

As you can see below, Emperor Watch & Jewellery had HK$165.5m of debt at December 2021, down from HK$638.7m a year prior. However, its balance sheet shows it holds HK$556.3m in cash, so it actually has HK$390.9m net cash.

How Healthy Is Emperor Watch & Jewellery's Balance Sheet?

We can see from the most recent balance sheet that Emperor Watch & Jewellery had liabilities of HK$535.4m falling due within a year, and liabilities of HK$94.1m due beyond that. Offsetting this, it had HK$556.3m in cash and HK$153.2m in receivables that were due within 12 months. So it can boast HK$80.0m more liquid assets than total liabilities.

This surplus suggests that Emperor Watch & Jewellery has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Emperor Watch & Jewellery has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Emperor Watch & Jewellery grew its EBIT by 274% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Emperor Watch & Jewellery 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Emperor Watch & Jewellery 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. Happily for any shareholders, Emperor Watch & Jewellery 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.

Summing up

While it is always sensible to investigate a company's debt, in this case Emperor Watch & Jewellery has HK$390.9m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 345% of that EBIT to free cash flow, bringing in HK$939m. So is Emperor Watch & Jewellery'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, we've discovered 2 warning signs for Emperor Watch & Jewellery that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.