Frontier Services Group (HKG:500) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Frontier Services Group Limited (HKG:500) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Frontier Services Group

How Much Debt Does Frontier Services Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Frontier Services Group had HK$219.1m of debt, an increase on HK$199.6m, over one year. On the flip side, it has HK$201.8m in cash leading to net debt of about HK$17.2m.

How Healthy Is Frontier Services Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Frontier Services Group had liabilities of HK$490.8m due within 12 months and liabilities of HK$35.7m due beyond that. On the other hand, it had cash of HK$201.8m and HK$287.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$37.0m.

Since publicly traded Frontier Services Group shares are worth a total of HK$367.7m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Frontier Services Group's low debt to EBITDA ratio of 0.18 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.7 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. We also note that Frontier Services Group improved its EBIT from a last year's loss to a positive HK$71m. When analysing debt levels, the balance sheet is the obvious place to start. But it is Frontier Services Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Considering the last year, Frontier Services Group actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Frontier Services Group's conversion of EBIT to free cash flow and interest cover definitely weigh on it, in our esteem. But its net debt to EBITDA tells a very different story, and suggests some resilience. We think that Frontier Services Group's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Frontier Services Group that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.