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 Crocodile Garments Limited (HKG:122) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Crocodile Garments Carry?
The image below, which you can click on for greater detail, shows that at January 2019 Crocodile Garments had debt of HK$790.0m, up from HK$642.5m in one year. On the flip side, it has HK$461.4m in cash leading to net debt of about HK$328.6m.
How Strong Is Crocodile Garments's Balance Sheet?
We can see from the most recent balance sheet that Crocodile Garments had liabilities of HK$649.1m falling due within a year, and liabilities of HK$248.6m due beyond that. Offsetting these obligations, it had cash of HK$461.4m as well as receivables valued at HK$18.5m due within 12 months. So its liabilities total HK$417.7m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of HK$559.1m. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is Crocodile Garments's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Over 12 months, Crocodile Garments saw its revenue hold pretty steady. While that hardly impresses, its not too bad either.
Importantly, Crocodile Garments had negative earnings before interest and tax (EBIT), over the last year. To be specific the EBIT loss came in at HK$20m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled HK$120m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. For riskier companies like Crocodile Garments I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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