Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Kader Holdings Company Limited (HKG:180) does carry debt. But the more important question is: how much risk is that debt creating?
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. 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. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Kader Holdings
How Much Debt Does Kader Holdings Carry?
As you can see below, Kader Holdings had HK$323.8m of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has HK$125.3m in cash leading to net debt of about HK$198.5m.
A Look At Kader Holdings’ Liabilities
Zooming in on the latest balance sheet data, we can see that Kader Holdings had liabilities of HK$509.9m due within 12 months and liabilities of HK$64.1m due beyond that. Offsetting this, it had HK$125.3m in cash and HK$101.4m in receivables that were due within 12 months. So it has liabilities totalling HK$347.2m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of HK$385.0m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Kader Holdings has a debt to EBITDA ratio of 2.9 and its EBIT covered its interest expense 5.7 times. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. Notably, Kader Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of HK$42m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Kader Holdings’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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Kader Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
When it comes to the balance sheet, the standout positive for Kader Holdings was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren’t so heartening. For instance it seems like it has to struggle a bit to handle its total liabilities. Looking at all this data makes us feel a little cautious about Kader Holdings’s debt levels. While we appreciate debt can enhance returns on equity, we’d suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Kader Holdings has 2 warning signs (and 1 which is concerning) we think you should know about.
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.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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