These 4 Measures Indicate That Hong Leong Asia (SGX:H22) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Hong Leong Asia Ltd. (SGX:H22) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hong Leong Asia

What Is Hong Leong Asia's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Hong Leong Asia had S$823.3m of debt, an increase on S$761.3m, over one year. However, its balance sheet shows it holds S$1.35b in cash, so it actually has S$524.1m net cash.

How Strong Is Hong Leong Asia's Balance Sheet?

We can see from the most recent balance sheet that Hong Leong Asia had liabilities of S$2.92b falling due within a year, and liabilities of S$521.0m due beyond that. Offsetting these obligations, it had cash of S$1.35b as well as receivables valued at S$1.86b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$229.5m.

While this might seem like a lot, it is not so bad since Hong Leong Asia has a market capitalization of S$542.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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.

In addition to that, we're happy to report that Hong Leong Asia has boosted its EBIT by 41%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hong Leong Asia'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hong Leong Asia 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. In the last three years, Hong Leong Asia's free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While Hong Leong Asia does have more liabilities than liquid assets, it also has net cash of S$524.1m. And it impressed us with its EBIT growth of 41% over the last year. So we don't have any problem with Hong Leong Asia's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Hong Leong Asia insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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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