These 4 metrics indicate that Polyfair Holdings (HKG: 8532) is using debt a lot
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Above all, Polyfair Holdings Limited (HKG: 8532) carries a debt. But does this debt worry shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
Check out our latest analysis for Polyfair Holdings
What is the net debt of Polyfair Holdings?
The image below, which you can click for more details, shows that in September 2021, Polyfair Holdings was in debt of HK $ 130.5 million, compared to HK $ 104.1 million in one year. However, he also had HK $ 12.7 million in cash, so his net debt is HK $ 117.8 million.
How healthy is Polyfair Holdings’ balance sheet?
We can see from the most recent balance sheet that Polyfair Holdings had liabilities of HK $ 187.4 million due within one year, and debts of HK $ 805.0,000 due beyond. In compensation for these obligations, he had cash of HK $ 12.7 million as well as receivables valued at HK $ 194.4 million due within 12 months. So he actually has HK $ 18.9million Following liquid assets as total liabilities.
It is good to see that Polyfair Holdings has a lot of liquidity on its balance sheet, which suggests prudent liability management. Given that he has easily sufficient short-term liquidity, we don’t think he will have any problems with his lenders.
We measure a company’s indebtedness relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). Thus, we look at debt versus earnings with and without amortization expenses.
Low 1.5x interest coverage and an unusually high net debt to EBITDA ratio of 19.6 shook our confidence in Polyfair Holdings like a punch in the gut. This means that we would consider him to be in heavy debt. Worse yet, Polyfair Holdings has seen its EBIT reach 31% over the past 12 months. If profits continue to follow this path, it will be more difficult to pay off this debt than to convince us to run a marathon in the rain. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in isolation; since Polyfair Holdings will need revenue to repay this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. During the past two years, Polyfair Holdings has experienced substantial total negative free cash flow. While investors no doubt expect this situation to reverse in due course, this clearly means that its use of debt is riskier.
Our point of view
At first glance, Polyfair Holdings’ EBIT conversion to free cash flow left us hesitant about the stock, and its EBIT growth rate was no more attractive than the single empty restaurant on the most night. responsible for the year. But at least he’s pretty decent to stay on top of his total liabilities; it’s encouraging. Overall, we think it’s fair to say that Polyfair Holdings has enough debt that there is real risk around the balance sheet. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. 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 off the balance sheet. We have identified 4 warning signs with Polyfair Holdings (at least 3 that shouldn’t be ignored), and understanding them should be part of your investment process.
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.