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. As with many other companies Veeko International Holdings Limited (HKG:1173) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Veeko International Holdings Carry?
The chart below, which you can click on for greater detail, shows that Veeko International Holdings had HK$265.6m in debt in March 2019; about the same as the year before. However, it also had HK$56.1m in cash, and so its net debt is HK$209.5m.
How Healthy Is Veeko International Holdings's Balance Sheet?
We can see from the most recent balance sheet that Veeko International Holdings had liabilities of HK$371.5m falling due within a year, and liabilities of HK$21.5m due beyond that. Offsetting these obligations, it had cash of HK$56.1m as well as receivables valued at HK$49.5m due within 12 months. So its liabilities total HK$287.4m more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's HK$201.4m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Veeko International Holdings 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, Veeko International Holdings made a loss at the EBIT level, and saw its revenue drop to HK$1.7b, which is a fall of 12%. That's not what we would hope to see.
While Veeko International Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable HK$63m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of HK$79m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. For riskier companies like Veeko International Holdings I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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