Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Orange Sky Golden Harvest Entertainment (Holdings) Limited (HKG:1132) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Orange Sky Golden Harvest Entertainment (Holdings)'s Debt?
The image below, which you can click on for greater detail, shows that Orange Sky Golden Harvest Entertainment (Holdings) had debt of HK$1.06b at the end of December 2019, a reduction from HK$1.30b over a year. However, its balance sheet shows it holds HK$1.07b in cash, so it actually has HK$11.2m net cash.
How Healthy Is Orange Sky Golden Harvest Entertainment (Holdings)'s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Orange Sky Golden Harvest Entertainment (Holdings) had liabilities of HK$792.9m due within 12 months and liabilities of HK$1.77b due beyond that. Offsetting these obligations, it had cash of HK$1.07b as well as receivables valued at HK$216.8m due within 12 months. So it has liabilities totalling HK$1.28b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the HK$543.1m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Orange Sky Golden Harvest Entertainment (Holdings) would probably need a major re-capitalization if its creditors were to demand repayment. Given that Orange Sky Golden Harvest Entertainment (Holdings) has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.
Importantly, Orange Sky Golden Harvest Entertainment (Holdings)'s EBIT fell a jaw-dropping 33% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is Orange Sky Golden Harvest Entertainment (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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Orange Sky Golden Harvest Entertainment (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. In the last two years, Orange Sky Golden Harvest Entertainment (Holdings)'s free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Although Orange Sky Golden Harvest Entertainment (Holdings)'s balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$11.2m. Unfortunately, though, both its struggle level of total liabilities and its EBIT growth rate leave us concerned about Orange Sky Golden Harvest Entertainment (Holdings) So despite the cash, we do think it carries some risks. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Orange Sky Golden Harvest Entertainment (Holdings) (1 shouldn't be ignored!) that you should be aware of before investing here.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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