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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Qian Hu Corporation Limited (SGX:BCV) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Qian Hu
What Is Qian Hu's Debt?
As you can see below, Qian Hu had S$16.7m of debt at June 2019, down from S$17.8m a year prior. However, it does have S$14.0m in cash offsetting this, leading to net debt of about S$2.63m.
How Healthy Is Qian Hu's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Qian Hu had liabilities of S$28.8m due within 12 months and liabilities of S$789.1k due beyond that. Offsetting these obligations, it had cash of S$14.0m as well as receivables valued at S$17.5m due within 12 months. So it actually has S$1.96m more liquid assets than total liabilities.
This short term liquidity is a sign that Qian Hu could probably pay off its debt with ease, as its balance sheet is far from stretched.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Given net debt is only 0.67 times EBITDA, it is initially surprising to see that Qian Hu's EBIT has low interest coverage of 2.2 times. So one way or the other, it's clear the debt levels are not trivial. Sadly, Qian Hu's EBIT actually dropped 8.1% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Qian Hu 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.