Yahoo Finance These 4 Measures Indicate That Frontage Holdings (HKG:1521) Is Using Debt Safely
Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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. Importantly, Frontage Holdings Corporation (HKG:1521) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Frontage Holdings
What Is Frontage Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that Frontage Holdings had debt of US$2.33m at the end of June 2019, a reduction from US$10.7m over a year. But it also has US$212.6m in cash to offset that, meaning it has US$210.3m net cash.
A Look At Frontage Holdings's Liabilities
According to the last reported balance sheet, Frontage Holdings had liabilities of US$29.5m due within 12 months, and liabilities of US$13.6m due beyond 12 months. Offsetting this, it had US$212.6m in cash and US$34.7m in receivables that were due within 12 months. So it actually has US$204.1m more liquid assets than total liabilities.
This excess liquidity suggests that Frontage Holdings is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Frontage Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
Another good sign is that Frontage Holdings has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Frontage Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Frontage Holdings 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, Frontage Holdings produced sturdy free cash flow equating to 54% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Frontage Holdings has net cash of US$210.3m, as well as more liquid assets than liabilities. And we liked the look of last year's 23% year-on-year EBIT growth. So is Frontage Holdings's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Frontage Holdings's earnings per share history for free.
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 spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
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