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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Ares Asia Limited (HKG:645) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Ares Asia
What Is Ares Asia's Debt?
As you can see below, Ares Asia had US$2.96m of debt at March 2019, down from US$49.5m a year prior. But it also has US$3.85m in cash to offset that, meaning it has US$892.0k net cash.
A Look At Ares Asia's Liabilities
According to the balance sheet data, Ares Asia had liabilities of US$18.8m due within 12 months, but no longer term liabilities. Offsetting these obligations, it had cash of US$3.85m as well as receivables valued at US$22.3m due within 12 months. So it can boast US$7.30m more liquid assets than total liabilities.
This luscious liquidity implies that Ares Asia's balance sheet is sturdy like a giant sequoia tree. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Ares Asia has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Ares Asia's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Ares Asia saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.
So How Risky Is Ares Asia?
While Ares Asia lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow US$43m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. For riskier companies like Ares Asia I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.