Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Frontage Holdings Corporation (HKG:1521) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Frontage Holdings

What Is Frontage Holdings's Net Debt?

As you can see below, at the end of June 2022, Frontage Holdings had US$11.3m of debt, up from none a year ago. Click the image for more detail. However, it does have US$72.3m in cash offsetting this, leading to net cash of US$61.0m.

A Look At Frontage Holdings' Liabilities

According to the last reported balance sheet, Frontage Holdings had liabilities of US$82.9m due within 12 months, and liabilities of US$82.0m due beyond 12 months. Offsetting this, it had US$72.3m in cash and US$69.0m in receivables that were due within 12 months. So its liabilities total US$23.7m more than the combination of its cash and short-term receivables.

Since publicly traded Frontage Holdings shares are worth a total of US$593.8m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Frontage Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Frontage Holdings has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Frontage Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Frontage Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Frontage Holdings recorded free cash flow of 24% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

We could understand if investors are concerned about Frontage Holdings's liabilities, but we can be reassured by the fact it has has net cash of US$61.0m. And we liked the look of last year's 27% year-on-year EBIT growth. So we don't think Frontage Holdings's use of debt is risky. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Frontage Holdings insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.