Does Hong Leong Asia (SGX:H22) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Hong Leong Asia Ltd. (SGX:H22) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hong Leong Asia

What Is Hong Leong Asia's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Hong Leong Asia had debt of S$823.3m, up from S$761.3m in one year. But on the other hand it also has S$1.35b in cash, leading to a S$524.1m net cash position.

A Look At Hong Leong Asia's Liabilities

Zooming in on the latest balance sheet data, we can see that Hong Leong Asia had liabilities of S$2.92b due within 12 months and liabilities of S$521.0m due beyond that. On the other hand, it had cash of S$1.35b and S$1.84b worth of receivables due within a year. So it has liabilities totalling S$248.2m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Hong Leong Asia is worth S$744.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Hong Leong Asia also has more cash than debt, so we're pretty confident it can manage its debt safely.

Hong Leong Asia's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hong Leong Asia can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Hong Leong Asia may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Hong Leong Asia recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While Hong Leong Asia does have more liabilities than liquid assets, it also has net cash of S$524.1m. So we are not troubled with Hong Leong Asia's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Hong Leong Asia 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. 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.
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