The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Intron Technology Holdings Limited (HKG:1760) does carry debt. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Intron Technology Holdings's Net Debt?
As you can see below, at the end of June 2019, Intron Technology Holdings had CN¥486.6m of debt, up from CN¥312.3m a year ago. Click the image for more detail. But on the other hand it also has CN¥579.9m in cash, leading to a CN¥93.3m net cash position.
How Healthy Is Intron Technology Holdings's Balance Sheet?
According to the last reported balance sheet, Intron Technology Holdings had liabilities of CN¥1.04b due within 12 months, and liabilities of CN¥20.5m due beyond 12 months. On the other hand, it had cash of CN¥579.9m and CN¥763.1m worth of receivables due within a year. So it can boast CN¥281.7m more liquid assets than total liabilities.
This short term liquidity is a sign that Intron Technology Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Intron Technology Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Intron Technology Holdings grew its EBIT by 15% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Intron Technology Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Intron Technology Holdings 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. Over the last three years, Intron Technology Holdings saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
While it is always sensible to investigate a company's debt, in this case Intron Technology Holdings has CN¥93.3m in net cash and a decent-looking balance sheet. And we liked the look of last year's 15% year-on-year EBIT growth. So we are not troubled with Intron Technology Holdings'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. Take risks, for example - Intron Technology Holdings has 5 warning signs (and 2 which can't be ignored) we think you should know about.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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