Is HK Asia Holdings (HKG:1723) Using Too Much Debt?

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.' 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, HK Asia Holdings Limited (HKG:1723) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for HK Asia Holdings

What Is HK Asia Holdings's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 HK Asia Holdings had debt of HK$12.0m, up from none in one year. But it also has HK$65.9m in cash to offset that, meaning it has HK$53.9m net cash.

How Healthy Is HK Asia Holdings's Balance Sheet?

We can see from the most recent balance sheet that HK Asia Holdings had liabilities of HK$24.6m falling due within a year, and liabilities of HK$2.45m due beyond that. Offsetting these obligations, it had cash of HK$65.9m as well as receivables valued at HK$1.42m due within 12 months. So it can boast HK$40.3m more liquid assets than total liabilities.

This surplus suggests that HK Asia Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, HK Asia Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, HK Asia Holdings's EBIT dived 10%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is HK Asia Holdings's earnings that will influence how the balance sheet holds up in the future. 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. HK Asia 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. Over the last three years, HK Asia Holdings barely recorded positive free cash flow, in total. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that HK Asia Holdings has net cash of HK$53.9m, as well as more liquid assets than liabilities. So we are not troubled with HK Asia Holdings's debt use. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with HK Asia Holdings , and understanding them should be part of your investment process.

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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This article by Simply Wall St is general in nature. 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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