Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 World Houseware (Holdings) Limited (HKG:713) 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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is World Houseware (Holdings)’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that World Houseware (Holdings) had HK$207.2m of debt in June 2020, down from HK$361.4m, one year before. However, it also had HK$53.2m in cash, and so its net debt is HK$154.0m.
How Strong Is World Houseware (Holdings)’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that World Houseware (Holdings) had liabilities of HK$468.8m due within 12 months and liabilities of HK$441.7m due beyond that. On the other hand, it had cash of HK$53.2m and HK$288.4m worth of receivables due within a year. So it has liabilities totalling HK$569.1m more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the HK$206.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we’d watch its balance sheet closely, without a doubt. At the end of the day, World Houseware (Holdings) would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is World Houseware (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.
Over 12 months, World Houseware (Holdings) made a loss at the EBIT level, and saw its revenue drop to HK$722m, which is a fall of 20%. That makes us nervous, to say the least.
While World Houseware (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$103.9m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. But we think that is unlikely, given it is low on liquid assets, and burned through HK$14.5m in the last year. So we think this stock is risky, like walking through a dirty dog park with a mask on. 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. Consider risks, for instance. Every company has them, and we’ve spotted 1 warning sign for World Houseware (Holdings) you should know about.
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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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. 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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