Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Hiap Hoe Limited (SGX:5JK) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Hiap Hoe's Net Debt?
The chart below, which you can click on for greater detail, shows that Hiap Hoe had S$710.4m in debt in June 2020; about the same as the year before. On the flip side, it has S$297.0m in cash leading to net debt of about S$413.4m.
How Healthy Is Hiap Hoe's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Hiap Hoe had liabilities of S$465.4m due within 12 months and liabilities of S$386.2m due beyond that. Offsetting these obligations, it had cash of S$297.0m as well as receivables valued at S$6.15m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$548.5m.
The deficiency here weighs heavily on the S$287.0m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Hiap Hoe would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hiap Hoe will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Hiap Hoe had a loss before interest and tax, and actually shrunk its revenue by 16%, to S$114m. We would much prefer see growth.
Not only did Hiap Hoe's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost S$2.0m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of S$4.8m. And until that time we think this is a risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Hiap Hoe that you should be aware of before investing here.
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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