Is Dragon Crown Group Holdings (HKG:935) Using Too Much Debt?

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. 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 Dragon Crown Group Holdings Limited (HKG:935) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Dragon Crown Group Holdings

What Is Dragon Crown Group Holdings’s Net Debt?

As you can see below, at the end of December 2019, Dragon Crown Group Holdings had HK$198.5m of debt, up from HK$175.5m a year ago. Click the image for more detail. However, its balance sheet shows it holds HK$244.1m in cash, so it actually has HK$45.6m net cash.

SEHK:935 Historical Debt May 7th 2020
SEHK:935 Historical Debt May 7th 2020

How Healthy Is Dragon Crown Group Holdings’s Balance Sheet?

According to the last reported balance sheet, Dragon Crown Group Holdings had liabilities of HK$85.6m due within 12 months, and liabilities of HK$178.3m due beyond 12 months. On the other hand, it had cash of HK$244.1m and HK$59.3m worth of receivables due within a year. So it actually has HK$39.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Dragon Crown Group Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Dragon Crown Group Holdings boasts net cash, so it’s fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Dragon Crown Group Holdings if management cannot prevent a repeat of the 28% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Dragon Crown Group 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Dragon Crown Group 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. Happily for any shareholders, Dragon Crown Group Holdings actually produced more free cash flow than EBIT over the last three years. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Dragon Crown Group Holdings has net cash of HK$45.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of HK$111m, being 142% of its EBIT. So we are not troubled with Dragon Crown Group Holdings’s debt use. 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. Case in point: We’ve spotted 4 warning signs for Dragon Crown Group Holdings you should be aware of, and 1 of them is potentially serious.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.