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.' 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. We can see that Enterprise Development Holdings Limited (HKG:1808) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Enterprise Development Holdings's Debt?
The image below, which you can click on for greater detail, shows that Enterprise Development Holdings had debt of CN¥17.4m at the end of June 2019, a reduction from CN¥30.2m over a year. However, its balance sheet shows it holds CN¥98.6m in cash, so it actually has CN¥81.2m net cash.
A Look At Enterprise Development Holdings's Liabilities
We can see from the most recent balance sheet that Enterprise Development Holdings had liabilities of CN¥52.7m falling due within a year, and liabilities of CN¥1.93m due beyond that. Offsetting this, it had CN¥98.6m in cash and CN¥43.9m in receivables that were due within 12 months. So it can boast CN¥87.9m more liquid assets than total liabilities.
This surplus liquidity suggests that Enterprise Development Holdings's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, it seems its balance sheet is as strong as a black-belt karate master. Succinctly put, Enterprise Development Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Enterprise Development Holdings will need earnings to service that debt. 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.
In the last year Enterprise Development Holdings actually shrunk its revenue by 57%, to CN¥106m. To be frank that doesn't bode well.
So How Risky Is Enterprise Development Holdings?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Enterprise Development Holdings lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥30m and booked a CN¥29m accounting loss. But the saving grace is the CN¥99m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. For riskier companies like Enterprise Development Holdings 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.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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