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. Importantly, HomeChoice International plc (JSE:HIL) does carry debt. But should shareholders be worried about its use of debt?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for HomeChoice International
You can click the graphic below for the historical numbers, but it shows that as of June 2024 HomeChoice International had R2.49b of debt, an increase on R2.01b, over one year. However, it also had R191.0m in cash, and so its net debt is R2.30b.
Zooming in on the latest balance sheet data, we can see that HomeChoice International had liabilities of R514.0m due within 12 months and liabilities of R2.49b due beyond that. Offsetting this, it had R191.0m in cash and R1.29b in receivables that were due within 12 months. So its liabilities total R1.53b more than the combination of its cash and short-term receivables.
HomeChoice International has a market capitalization of R3.13b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With net debt to EBITDA of 4.1 HomeChoice International has a fairly noticeable amount of debt. On the plus side, its EBIT was 7.7 times its interest expense, and its net debt to EBITDA, was quite high, at 4.1. We note that HomeChoice International grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since HomeChoice International will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, HomeChoice International saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
HomeChoice International's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. In particular, its EBIT growth rate was re-invigorating. When we consider all the factors discussed, it seems to us that HomeChoice International is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that HomeChoice International is showing 4 warning signs in our investment analysis , and 2 of those are a bit unpleasant...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.