David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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. As with many other companies Fresh Express Delivery Holdings Group Co., Limited (HKG:1175) makes use of debt. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Fresh Express Delivery Holdings Group’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 Fresh Express Delivery Holdings Group had CN¥88.8m of debt, an increase on CN¥53.0m, over one year. However, because it has a cash reserve of CN¥12.9m, its net debt is less, at about CN¥75.9m.
A Look At Fresh Express Delivery Holdings Group’s Liabilities
The latest balance sheet data shows that Fresh Express Delivery Holdings Group had liabilities of CN¥119.6m due within a year, and liabilities of CN¥2.76m falling due after that. On the other hand, it had cash of CN¥12.9m and CN¥24.6m worth of receivables due within a year. So it has liabilities totalling CN¥84.8m more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company’s CN¥78.5m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since Fresh Express Delivery Holdings Group 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, Fresh Express Delivery Holdings Group reported revenue of CN¥1.5b, which is a gain of 221%, although it did not report any earnings before interest and tax. That’s virtually the hole-in-one of revenue growth!
Even though Fresh Express Delivery Holdings Group managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost a very considerable CN¥46m at the EBIT level. When we look at that alongside the significant liabilities, we’re not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through CN¥7.7m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we’ve identified 3 warning signs for Fresh Express Delivery Holdings Group (1 doesn’t sit too well with us) you should be aware of.
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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