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.' 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. We can see that Willas-Array Electronics (Holdings) Limited (SGX:BDR) does use debt in its business. But is this debt a concern to shareholders?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Willas-Array Electronics (Holdings) Carry?
The image below, which you can click on for greater detail, shows that Willas-Array Electronics (Holdings) had debt of HK$491.1m at the end of March 2021, a reduction from HK$670.9m over a year. On the flip side, it has HK$216.9m in cash leading to net debt of about HK$274.2m.
How Healthy Is Willas-Array Electronics (Holdings)'s Balance Sheet?
We can see from the most recent balance sheet that Willas-Array Electronics (Holdings) had liabilities of HK$910.8m falling due within a year, and liabilities of HK$42.9m due beyond that. Offsetting this, it had HK$216.9m in cash and HK$856.9m in receivables that were due within 12 months. So it can boast HK$120.1m more liquid assets than total liabilities.
This surplus strongly suggests that Willas-Array Electronics (Holdings) has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Willas-Array Electronics (Holdings) has net debt worth 2.4 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.3 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Notably, Willas-Array Electronics (Holdings) made a loss at the EBIT level, last year, but improved that to positive EBIT of HK$99m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Willas-Array Electronics (Holdings)'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Willas-Array Electronics (Holdings) actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
The good news is that Willas-Array Electronics (Holdings)'s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. Zooming out, Willas-Array Electronics (Holdings) seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. We've identified 4 warning signs with Willas-Array Electronics (Holdings) , and understanding them should be part of your investment process.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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