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. We can see that AMVIG Holdings Limited (HKG:2300) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for AMVIG Holdings
How Much Debt Does AMVIG Holdings Carry?
The image below, which you can click on for greater detail, shows that at December 2018 AMVIG Holdings had debt of HK$1.76b, up from HK$1.47b in one year. However, it does have HK$1.27b in cash offsetting this, leading to net debt of about HK$491.5m.
A Look At AMVIG Holdings's Liabilities
The latest balance sheet data shows that AMVIG Holdings had liabilities of HK$987.7m due within a year, and liabilities of HK$1.78b falling due after that. On the other hand, it had cash of HK$1.27b and HK$701.7m worth of receivables due within a year. So its liabilities total HK$794.1m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since AMVIG Holdings has a market capitalization of HK$1.72b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
AMVIG Holdings has net debt of just 0.89 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 7.1 times, which is more than adequate. Fortunately, AMVIG Holdings grew its EBIT by 8.8% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since AMVIG Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.