Link investor

We think Wine’s Link International Holdings (HKG:8509) is taking risks with its debt

David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Wine’s Link International Holdings Limited (HKG:8509) has a debt on its balance sheet. But should shareholders worry about its use of debt?

What risk does debt carry?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

Check out our latest analysis for Wine’s Link International Holdings

How much debt does Wine’s Link International Holdings have?

As you can see below, at the end of March 2022, Wine’s Link International Holdings had a debt of HK$128.3 million, compared to HK$88.1 million a year ago. Click on the image for more details. However, since he has a cash reserve of HK$5.78 million, his net debt is lower at around HK$122.5 million.

SEHK: 8509 Historical Debt to Equity June 26, 2022

A look at the liabilities of Wine’s Link International Holdings

According to the latest published balance sheet, Wine’s Link International Holdings had liabilities of HK$157.4 million due within 12 months and liabilities of HK$1.70 million due beyond 12 months. In return, he had HK$5.78 million in cash and HK$51.9 million in debt due within 12 months. It therefore has liabilities totaling HK$101.4 million more than its cash and short-term receivables, combined.

While that might sound like a lot, it’s not too bad since Wine’s Link International Holdings has a market capitalization of HK$190.0 million, so it could likely bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 4.5 Wine’s Link International Holdings has a fairly notable amount of debt. On the positive side, its EBIT was 9.5 times its interest expense, and its net debt to EBITDA ratio was quite high, at 4.5. It is important to note that Wine’s Link International Holdings’ EBIT has fallen by 30% over the last twelve months. If this decline continues, it will be more difficult to repay debts than to sell foie gras at a vegan convention. There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of Wine’s Link International Holdings that will influence the balance sheet in the future. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.

Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Fortunately for all shareholders, Wine’s Link International Holdings has actually produced more free cash flow than EBIT for the past three years. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our point of view

Neither Wine’s Link International Holdings’ ability to grow its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is that it seems to be able to easily convert EBIT to free cash flow. We think Wine’s Link International Holdings’ debt makes it a bit risky, after looking at the aforementioned data points together. Not all risk is bad, as it can increase stock price returns if it pays off, but this leverage risk is worth keeping in mind. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. To this end, you should be aware of the 3 warning signs we spotted with Wine’s Link International Holdings.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.