OKG Technology Holdings (HKG:1499) Seems To Be Using A Lot Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies OKG Technology Holdings Limited (HKG:1499) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for OKG Technology Holdings

What Is OKG Technology Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 OKG Technology Holdings had HK$715.0m of debt, an increase on HK$591.5m, over one year. However, because it has a cash reserve of HK$110.3m, its net debt is less, at about HK$604.8m.

A Look At OKG Technology Holdings' Liabilities

According to the last reported balance sheet, OKG Technology Holdings had liabilities of HK$876.1m due within 12 months, and liabilities of HK$60.0k due beyond 12 months. On the other hand, it had cash of HK$110.3m and HK$114.4m worth of receivables due within a year. So it has liabilities totalling HK$651.5m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since OKG Technology Holdings has a market capitalization of HK$1.66b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

OKG Technology Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (47.3), and fairly weak interest coverage, since EBIT is just 1.3 times the interest expense. The debt burden here is substantial. Worse, OKG Technology Holdings's EBIT was down 84% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is OKG Technology 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, OKG Technology Holdings saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, OKG Technology Holdings's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to handle its total liabilities isn't such a worry. Taking into account all the aforementioned factors, it looks like OKG Technology Holdings has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. While OKG Technology Holdings didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.