Is Hosken Passenger Logistics and Rail (JSE:HPR) A Risky Investment?

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.' 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. As with many other companies Hosken Passenger Logistics and Rail Limited (JSE:HPR) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Hosken Passenger Logistics and Rail

How Much Debt Does Hosken Passenger Logistics and Rail Carry?

As you can see below, Hosken Passenger Logistics and Rail had R363.8m of debt at March 2021, down from R517.5m a year prior. However, it does have R497.8m in cash offsetting this, leading to net cash of R134.0m.

How Strong Is Hosken Passenger Logistics and Rail's Balance Sheet?

The latest balance sheet data shows that Hosken Passenger Logistics and Rail had liabilities of R420.7m due within a year, and liabilities of R597.4m falling due after that. Offsetting these obligations, it had cash of R497.8m as well as receivables valued at R72.0m due within 12 months. So its liabilities total R448.4m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Hosken Passenger Logistics and Rail is worth R1.02b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Hosken Passenger Logistics and Rail boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Hosken Passenger Logistics and Rail's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hosken Passenger Logistics and Rail will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Hosken Passenger Logistics and Rail 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. Happily for any shareholders, Hosken Passenger Logistics and Rail actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While Hosken Passenger Logistics and Rail does have more liabilities than liquid assets, it also has net cash of R134.0m. The cherry on top was that in converted 100% of that EBIT to free cash flow, bringing in R322m. So we are not troubled with Hosken Passenger Logistics and Rail's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Hosken Passenger Logistics and Rail (of which 1 can't be ignored!) 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.

If you’re looking to trade a wide range of investments, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.