Is Comba Telecom Systems Holdings (HKG:2342) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Comba Telecom Systems Holdings Limited (HKG:2342) makes use of debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Comba Telecom Systems Holdings

How Much Debt Does Comba Telecom Systems Holdings Carry?

As you can see below, Comba Telecom Systems Holdings had HK$1.42b of debt at June 2020, down from HK$1.88b a year prior. But on the other hand it also has HK$1.77b in cash, leading to a HK$353.4m net cash position.

How Strong Is Comba Telecom Systems Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Comba Telecom Systems Holdings had liabilities of HK$5.16b due within 12 months and liabilities of HK$1.14b due beyond that. Offsetting these obligations, it had cash of HK$1.77b as well as receivables valued at HK$3.90b due within 12 months. So it has liabilities totalling HK$620.4m more than its cash and near-term receivables, combined.

Given Comba Telecom Systems Holdings has a market capitalization of HK$6.37b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Comba Telecom Systems Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Notably, Comba Telecom Systems Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of HK$34m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Comba Telecom Systems Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Comba Telecom 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. Over the last year, Comba Telecom Systems Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Comba Telecom Systems Holdings has HK$353.4m in net cash. And it impressed us with free cash flow of HK$107m, being 316% of its EBIT. So we are not troubled with Comba Telecom 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. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Comba Telecom Systems Holdings , and understanding them should be part of your investment process.

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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