Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that KNT Holdings Limited (HKG:1025) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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 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 KNT Holdings's Net Debt?
You can click the graphic below for the historical numbers, but it shows that KNT Holdings had HK$25.7m of debt in March 2019, down from HK$56.8m, one year before. However, it does have HK$97.2m in cash offsetting this, leading to net cash of HK$71.6m.
How Healthy Is KNT Holdings's Balance Sheet?
The latest balance sheet data shows that KNT Holdings had liabilities of HK$42.2m due within a year, and liabilities of HK$417.0k falling due after that. Offsetting this, it had HK$97.2m in cash and HK$20.9m in receivables that were due within 12 months. So it can boast HK$75.5m more liquid assets than total liabilities.
This excess liquidity suggests that KNT Holdings is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, KNT Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, KNT Holdings grew its EBIT by 8.1% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is KNT Holdings'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. KNT 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. Looking at the most recent three years, KNT Holdings recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While it is always sensible to investigate a company's debt, in this case KNT Holdings has HK$71.6m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 8.1% in the last twelve months. So we don't think KNT Holdings's use of debt is risky. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check KNT Holdings's dividend history, without delay!
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.