Does AAC Technologies Holdings (HKG:2018) have a healthy balance sheet?

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Mostly, AAC Technologies Holdings Inc. (HKG:2018) is in debt. But does this debt worry shareholders?

Why is debt risky?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.

Check out our latest analysis for AAC Technologies Holdings

How much debt does AAC Technologies Holdings have?

As you can see below, at the end of December 2021, AAC Technologies Holdings had a debt of 9.81 billion Canadian yen, compared to 8.43 billion Canadian yen a year ago. Click on the image for more details. However, he also had 6.05 billion Canadian yen in cash, so his net debt is 3.76 billion Canadian yen.

SEHK: 2018 Debt to Equity April 5, 2022

How healthy is AAC Technologies Holdings’ balance sheet?

Zooming in on the latest balance sheet data, we can see that AAC Technologies Holdings had liabilities of 9.67 billion Canadian yen due within 12 months and liabilities of 9.85 billion national yen due beyond. In compensation for these obligations, it had cash of 6.05 billion yen as well as receivables valued at 5.66 billion yen due within 12 months. It therefore has liabilities totaling 7.81 billion Canadian yen more than its cash and short-term receivables, combined.

This shortfall is not that bad because AAC Technologies Holdings is worth 18.9 billion Canadian yen and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Looking at its net debt to EBITDA of 0.99 and its interest coverage of 5.0 times, it seems to us that AAC Technologies Holdings is probably using debt quite sensibly. But the interest payments are certainly enough to make us think about the affordability of its debt. One way for AAC Technologies Holdings to overcome its debt would be to stop borrowing more but continue to grow its EBIT by about 10%, as it did last year. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether AAC Technologies Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, AAC Technologies Holdings has had free cash flow of 5.2% of EBIT, which is really quite low. For us, such a low cash conversion creates a bit of paranoia about the ability to extinguish the debt.

Our point of view

AAC Technologies Holdings’ struggle to convert EBIT to free cash flow made us doubt the strength of its balance sheet, but other data points we considered were relatively rewarding. But on the bright side, its ability to manage its debt, based on its EBITDA, isn’t too bad at all. We think AAC Technologies 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. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for AAC Technologies Holdings you should know.

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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.

About Myra R.

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