Here's Why Hor Kew (SGX:BBP) Has A Meaningful Debt Burden

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 note that Hor Kew Corporation Limited (SGX:BBP) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hor Kew

What Is Hor Kew's Net Debt?

As you can see below, Hor Kew had S$55.0m of debt at December 2023, down from S$59.6m a year prior. However, it does have S$25.3m in cash offsetting this, leading to net debt of about S$29.8m.

How Strong Is Hor Kew's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hor Kew had liabilities of S$56.3m due within 12 months and liabilities of S$30.9m due beyond that. Offsetting this, it had S$25.3m in cash and S$23.5m in receivables that were due within 12 months. So it has liabilities totalling S$38.4m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the S$14.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Hor Kew would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

Hor Kew has net debt worth 2.4 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 2.9 times the interest expense. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. Notably, Hor Kew's EBIT launched higher than Elon Musk, gaining a whopping 1,692% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hor Kew's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Hor Kew actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

We feel some trepidation about Hor Kew's difficulty level of total liabilities, but we've got positives to focus on, too. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. We think that Hor Kew's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Hor Kew (of which 1 can't be ignored!) you should know about.

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.