Is FIT Hon Teng (HKG:6088) A Risky Investment?

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.' 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 can see that FIT Hon Teng Limited (HKG:6088) does use debt in its business. 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for FIT Hon Teng

What Is FIT Hon Teng's Net Debt?

As you can see below, FIT Hon Teng had US$1.03b of debt at December 2022, down from US$1.27b a year prior. However, its balance sheet shows it holds US$1.05b in cash, so it actually has US$24.4m net cash.

How Strong Is FIT Hon Teng's Balance Sheet?

The latest balance sheet data shows that FIT Hon Teng had liabilities of US$1.54b due within a year, and liabilities of US$660.9m falling due after that. Offsetting this, it had US$1.05b in cash and US$735.4m in receivables that were due within 12 months. So it has liabilities totalling US$413.0m more than its cash and near-term receivables, combined.

This deficit isn't so bad because FIT Hon Teng is worth US$1.64b, and thus could probably raise enough capital to shore up 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. While it does have liabilities worth noting, FIT Hon Teng also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that FIT Hon Teng grew its EBIT by 142% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. 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 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. 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. During the last three years, FIT Hon Teng burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While FIT Hon Teng does have more liabilities than liquid assets, it also has net cash of US$24.4m. And it impressed us with its EBIT growth of 142% over the last year. So we are not troubled with FIT Hon Teng's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of FIT Hon Teng's earnings per share history for free.

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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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.