Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Keck Seng Investments (Hong Kong) Limited (HKG:184) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, 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 capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Keck Seng Investments (Hong Kong)'s Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Keck Seng Investments (Hong Kong) had HK$1.82b of debt, an increase on HK$1.60b, over one year. But on the other hand it also has HK$1.93b in cash, leading to a HK$102.3m net cash position.
How Healthy Is Keck Seng Investments (Hong Kong)'s Balance Sheet?
We can see from the most recent balance sheet that Keck Seng Investments (Hong Kong) had liabilities of HK$965.8m falling due within a year, and liabilities of HK$1.46b due beyond that. Offsetting these obligations, it had cash of HK$1.93b as well as receivables valued at HK$101.1m due within 12 months. So it has liabilities totalling HK$397.7m more than its cash and near-term receivables, combined.
Keck Seng Investments (Hong Kong) has a market capitalization of HK$1.58b, 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. While it does have liabilities worth noting, Keck Seng Investments (Hong Kong) also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, Keck Seng Investments (Hong Kong)'s EBIT dived 13%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is Keck Seng Investments (Hong Kong)'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Keck Seng Investments (Hong Kong) 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. During the last three years, Keck Seng Investments (Hong Kong) generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While Keck Seng Investments (Hong Kong) does have more liabilities than liquid assets, it also has net cash of HK$102.3m. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in HK$188m. So we don't have any problem with Keck Seng Investments (Hong Kong)'s use of debt. 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. Take risks, for example - Keck Seng Investments (Hong Kong) has 3 warning signs (and 1 which can't be ignored) we think you should know about.
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.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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