Is Orient Overseas (International) (HKG:316) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Orient Overseas (International) Limited (HKG:316) does carry debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that 316 is potentially undervalued!

What Is Orient Overseas (International)'s Net Debt?

You can click the graphic below for the historical numbers, but it shows that Orient Overseas (International) had US$231.3m of debt in June 2022, down from US$929.0m, one year before. But it also has US$11.0b in cash to offset that, meaning it has US$10.8b net cash.

A Look At Orient Overseas (International)'s Liabilities

According to the last reported balance sheet, Orient Overseas (International) had liabilities of US$4.15b due within 12 months, and liabilities of US$2.64b due beyond 12 months. Offsetting this, it had US$11.0b in cash and US$1.08b in receivables that were due within 12 months. So it actually has US$5.30b more liquid assets than total liabilities.

This luscious liquidity implies that Orient Overseas (International)'s balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Orient Overseas (International) boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Orient Overseas (International) grew its EBIT by 183% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Orient Overseas (International)'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Orient Overseas (International) 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 last three years, Orient Overseas (International) 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 we empathize with investors who find debt concerning, you should keep in mind that Orient Overseas (International) has net cash of US$10.8b, as well as more liquid assets than liabilities. The cherry on top was that in converted 115% of that EBIT to free cash flow, bringing in US$12b. The bottom line is that Orient Overseas (International)'s use of debt is absolutely fine. 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. To that end, you should learn about the 3 warning signs we've spotted with Orient Overseas (International) (including 1 which makes us a bit uncomfortable) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.