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.' 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, Hor Kew Corporation Limited (SGX:BBP) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Hor Kew Carry?
As you can see below, at the end of June 2019, Hor Kew had S$65.3m of debt, up from S$59.1m a year ago. Click the image for more detail. On the flip side, it has S$28.5m in cash leading to net debt of about S$36.8m.
How Healthy Is Hor Kew's Balance Sheet?
We can see from the most recent balance sheet that Hor Kew had liabilities of S$76.7m falling due within a year, and liabilities of S$34.6m due beyond that. On the other hand, it had cash of S$28.5m and S$21.5m worth of receivables due within a year. So it has liabilities totalling S$61.3m more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the S$7.29m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Hor Kew would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hor Kew 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.
Over 12 months, Hor Kew reported revenue of S$57m, which is a gain of 17%. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months Hor Kew produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable S$27m at the EBIT level. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it burned through S$3.2m in the last year. So we consider this a high risk stock, and we're worried its share price could sink faster than than a dingy with a great white shark attacking it. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Hor Kew's profit, revenue, and operating cashflow have changed over the last few years.
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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