Here's Why Hour Glass (SGX:AGS) Can Manage Its Debt Responsibly

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that The Hour Glass Limited (SGX:AGS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Hour Glass

What Is Hour Glass's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Hour Glass had debt of S$70.7m, up from S$33.9m in one year. But on the other hand it also has S$206.9m in cash, leading to a S$136.2m net cash position.

A Look At Hour Glass' Liabilities

The latest balance sheet data shows that Hour Glass had liabilities of S$163.7m due within a year, and liabilities of S$79.1m falling due after that. Offsetting these obligations, it had cash of S$206.9m as well as receivables valued at S$17.5m due within 12 months. So its liabilities total S$18.4m more than the combination of its cash and short-term receivables.

Of course, Hour Glass has a market capitalization of S$563.2m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Hour Glass boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Hour Glass saw its EBIT drop by 7.1% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hour Glass 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Hour Glass 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. Happily for any shareholders, Hour Glass 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.

Summing up

We could understand if investors are concerned about Hour Glass's liabilities, but we can be reassured by the fact it has has net cash of S$136.2m. And it impressed us with free cash flow of S$122m, being 104% of its EBIT. So is Hour Glass's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Hour Glass you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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