The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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, Kin Shing Holdings Limited (HKG:1630) does carry 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Kin Shing Holdings's Net Debt?
As you can see below, at the end of March 2019, Kin Shing Holdings had HK$167.1m of debt, up from HK$41.7m a year ago. Click the image for more detail. However, it does have HK$184.5m in cash offsetting this, leading to net cash of HK$17.4m.
How Strong Is Kin Shing Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Kin Shing Holdings had liabilities of HK$256.4m due within 12 months and liabilities of HK$2.20m due beyond that. On the other hand, it had cash of HK$184.5m and HK$223.7m worth of receivables due within a year. So it can boast HK$149.7m more liquid assets than total liabilities.
This surplus liquidity suggests that Kin Shing Holdings's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, Kin Shing Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact Kin Shing Holdings's saving grace is its low debt levels, because its EBIT has tanked 27% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Kin Shing Holdings'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Kin Shing Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Kin Shing Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While we empathize with investors who find debt concerning, you should keep in mind that Kin Shing Holdings has net cash of HK$17.4m, as well as more liquid assets than liabilities. So we don't have any problem with Kin Shing Holdings's use of debt. While Kin Shing Holdings didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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. Thank you for reading.