Is Tesson Holdings (HKG:1201) A Risky Investment?

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. We note that Tesson Holdings Limited (HKG:1201) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Tesson Holdings

What Is Tesson Holdings's Net Debt?

As you can see below, at the end of June 2020, Tesson Holdings had HK$304.6m of debt, up from HK$45.9m a year ago. Click the image for more detail. However, it does have HK$58.9m in cash offsetting this, leading to net debt of about HK$245.6m.

How Strong Is Tesson Holdings's Balance Sheet?

We can see from the most recent balance sheet that Tesson Holdings had liabilities of HK$1.72b falling due within a year, and liabilities of HK$184.1m due beyond that. Offsetting this, it had HK$58.9m in cash and HK$627.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$1.22b.

This deficit casts a shadow over the HK$478.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Tesson Holdings would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Tesson 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, Tesson Holdings made a loss at the EBIT level, and saw its revenue drop to HK$444m, which is a fall of 64%. That makes us nervous, to say the least.

Caveat Emptor

While Tesson 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. To be specific the EBIT loss came in at HK$24m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it vaporized HK$178m in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Tesson Holdings has 3 warning signs (and 2 which don't sit too well with us) we think 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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