We Think Hour Glass (SGX:AGS) Can Manage Its Debt With Ease

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.' 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. As with many other companies The Hour Glass Limited (SGX:AGS) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. 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.

View our latest analysis for Hour Glass

What Is Hour Glass's Debt?

As you can see below, Hour Glass had S$120.5m of debt, at September 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have S$218.0m in cash offsetting this, leading to net cash of S$97.5m.

A Look At Hour Glass' Liabilities

According to the last reported balance sheet, Hour Glass had liabilities of S$242.6m due within 12 months, and liabilities of S$66.4m due beyond 12 months. Offsetting these obligations, it had cash of S$218.0m as well as receivables valued at S$20.1m due within 12 months. So it has liabilities totalling S$70.8m more than its cash and near-term receivables, combined.

Given Hour Glass has a market capitalization of S$1.45b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Hour Glass 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 Hour Glass has boosted its EBIT by 52%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hour Glass 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. During the last three years, Hour Glass generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

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$97.5m. And it impressed us with free cash flow of S$114m, being 93% 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. For example Hour Glass has 2 warning signs (and 1 which can't be ignored) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.