Does Huobi Technology Holdings (HKG:1611) Have A Healthy Balance Sheet?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Huobi Technology Holdings Limited (HKG:1611) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Huobi Technology Holdings

What Is Huobi Technology Holdings's Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Huobi Technology Holdings had debt of HK$475.8m, up from HK$321.2m in one year. However, it also had HK$375.1m in cash, and so its net debt is HK$100.7m.

How Healthy Is Huobi Technology Holdings' Balance Sheet?

According to the last reported balance sheet, Huobi Technology Holdings had liabilities of HK$575.1m due within 12 months, and liabilities of HK$515.3m due beyond 12 months. Offsetting these obligations, it had cash of HK$375.1m as well as receivables valued at HK$78.5m due within 12 months. So its liabilities total HK$636.8m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Huobi Technology Holdings has a market capitalization of HK$2.00b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

Huobi Technology Holdings's net debt is sitting at a very reasonable 2.0 times its EBITDA, while its EBIT covered its interest expense just 3.1 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Shareholders should be aware that Huobi Technology Holdings's EBIT was down 48% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is Huobi Technology 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last two years, Huobi Technology Holdings's free cash flow amounted to 21% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over Huobi Technology Holdings's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least its net debt to EBITDA is not so bad. Looking at the bigger picture, it seems clear to us that Huobi Technology Holdings's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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 - Huobi Technology Holdings has 4 warning signs we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.