Is Automated Systems Holdings (HKG:771) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Automated Systems Holdings Limited (HKG:771) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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 Automated Systems Holdings

What Is Automated Systems Holdings's Net Debt?

As you can see below, Automated Systems Holdings had HK$145.9m of debt at December 2020, down from HK$501.1m a year prior. But on the other hand it also has HK$435.4m in cash, leading to a HK$289.5m net cash position.

How Strong Is Automated Systems Holdings' Balance Sheet?

According to the last reported balance sheet, Automated Systems Holdings had liabilities of HK$849.1m due within 12 months, and liabilities of HK$205.1m due beyond 12 months. On the other hand, it had cash of HK$435.4m and HK$435.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$183.2m.

Since publicly traded Automated Systems Holdings shares are worth a total of HK$1.32b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Automated Systems Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Automated Systems Holdings's load is not too heavy, because its EBIT was down 26% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Automated Systems Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Automated Systems Holdings 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. During the last three years, Automated Systems Holdings produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although Automated Systems Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$289.5m. So we are not troubled with Automated Systems Holdings's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Automated Systems Holdings that you should be aware of before investing here.

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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