These 4 Measures Indicate That Apex Ace Holding (HKG:6036) Is Using Debt Extensively

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.' 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 note that Apex Ace Holding Limited (HKG:6036) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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.

Check out our latest analysis for Apex Ace Holding

What Is Apex Ace Holding's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Apex Ace Holding had debt of HK$649.0m, up from HK$578.1m in one year. However, it also had HK$112.0m in cash, and so its net debt is HK$537.0m.

How Healthy Is Apex Ace Holding's Balance Sheet?

We can see from the most recent balance sheet that Apex Ace Holding had liabilities of HK$855.7m falling due within a year, and liabilities of HK$24.7m due beyond that. Offsetting this, it had HK$112.0m in cash and HK$670.2m in receivables that were due within 12 months. So its liabilities total HK$98.2m more than the combination of its cash and short-term receivables.

Since publicly traded Apex Ace Holding shares are worth a total of HK$632.4m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 8.0 hit our confidence in Apex Ace Holding like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that Apex Ace Holding achieved a positive EBIT of HK$57m in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Apex Ace Holding 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Apex Ace Holding reported free cash flow worth 6.0% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

To be frank both Apex Ace Holding's interest cover and its track record of managing its debt, based on its EBITDA, make us rather uncomfortable with its debt levels. But at least its level of total liabilities is not so bad. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Apex Ace Holding stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. Be aware that Apex Ace Holding is showing 2 warning signs in our investment analysis , and 1 of those is significant...

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.