Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that National Arts Entertainment and Culture Group Limited (HKG:8228) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is National Arts Entertainment and Culture Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 National Arts Entertainment and Culture Group had HK$2.01b of debt, an increase on HK$1.81b, over one year. Net debt is about the same, since the it doesn't have much cash.
A Look At National Arts Entertainment and Culture Group's Liabilities
According to the last reported balance sheet, National Arts Entertainment and Culture Group had liabilities of HK$1.75b due within 12 months, and liabilities of HK$554.7m due beyond 12 months. Offsetting this, it had HK$1.64m in cash and HK$147.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$2.16b.
This deficit casts a shadow over the HK$1.02b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, National Arts Entertainment and Culture Group would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is National Arts Entertainment and Culture Group'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.
In the last year National Arts Entertainment and Culture Group actually shrunk its revenue by 38%, to HK$143m. That makes us nervous, to say the least.
Not only did National Arts Entertainment and Culture Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable HK$160m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through HK$63m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. For riskier companies like National Arts Entertainment and Culture Group 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.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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