Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We note that Midland Holdings Limited (HKG:1200) has a debt on its balance sheet. But the more important question is: what risk does this debt create?
When is debt a problem?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for Midland Holdings
How much debt does Midland Holdings have?
You can click on the graph below for historical figures, but it shows that in December 2021, Midland Holdings had debt of HK$687.0 million, an increase of HK$228.0 million, on a year. But he also has HK$1.51 billion in cash to offset that, meaning he has a net cash of HK$818.5 million.
A look at the liabilities of Midland Holdings
The latest balance sheet data shows Midland Holdings had liabilities of HK$4.84 billion due within a year, and liabilities of HK$322.4 million falling due thereafter. . On the other hand, it had cash of HK$1.51 billion and HK$3.83 billion of receivables due within one year. He can therefore boast that he has HK$165.1 million more in liquid assets than total Passives.
This excess liquidity suggests that Midland Holdings is taking a cautious approach to debt. Because he has a lot of assets, he is unlikely to have any problems with his lenders. Simply put, the fact that Midland Holdings has more cash than debt is arguably a good indication that it can safely manage its debt.
Pleasantly, Midland Holdings is growing its EBIT faster than former Australian Prime Minister Bob Hawke dropped a yard glass, with a 919% gain over the last twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Midland Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. Although Midland Holdings has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) to free cash flow, to help us understand how quickly it’s building ( or erodes) this treasury. balance. Fortunately for all shareholders, Midland Holdings has actually produced more free cash flow than EBIT for the past two years. There’s nothing better than incoming money to stay in the good books of your lenders.
While it’s always a good idea to investigate a company’s debt, in this case Midland Holdings has HK$818.5 million in net cash and a decent balance sheet. The icing on the cake was converting 665% of that EBIT into free cash flow, bringing in HK$685 million. We therefore do not believe that Midland Holdings’ use of debt is risky. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 3 warning signs for Midland Holdings which you should be aware of before investing here.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeright now.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.