Here's Why FIT Hon Teng (HKG:6088) Can Manage Its Debt Responsibly

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.' 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, FIT Hon Teng Limited (HKG:6088) does carry debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for FIT Hon Teng

How Much Debt Does FIT Hon Teng Carry?

As you can see below, at the end of June 2023, FIT Hon Teng had US$1.40b of debt, up from US$1.26b a year ago. Click the image for more detail. But it also has US$1.49b in cash to offset that, meaning it has US$86.1m net cash.

How Strong Is FIT Hon Teng's Balance Sheet?

According to the last reported balance sheet, FIT Hon Teng had liabilities of US$2.27b due within 12 months, and liabilities of US$75.3m due beyond 12 months. Offsetting these obligations, it had cash of US$1.49b as well as receivables valued at US$630.6m due within 12 months. So it has liabilities totalling US$229.1m more than its cash and near-term receivables, combined.

FIT Hon Teng has a market capitalization of US$1.06b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, FIT Hon Teng boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, FIT Hon Teng'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. 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 FIT Hon Teng's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While FIT Hon Teng has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, FIT Hon Teng recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While FIT Hon Teng does have more liabilities than liquid assets, it also has net cash of US$86.1m. And it impressed us with free cash flow of US$427m, being 66% of its EBIT. So we are not troubled with FIT Hon Teng's debt use. 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 - FIT Hon Teng has 1 warning sign 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.