Is Unity Group Holdings International (HKG:1539) A Risky Investment?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Unity Group Holdings International Limited (HKG:1539) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Unity Group Holdings International

What Is Unity Group Holdings International's Net Debt?

As you can see below, Unity Group Holdings International had HK$83.8m of debt at September 2022, down from HK$166.3m a year prior. However, because it has a cash reserve of HK$33.9m, its net debt is less, at about HK$49.9m.

How Strong Is Unity Group Holdings International's Balance Sheet?

According to the last reported balance sheet, Unity Group Holdings International had liabilities of HK$210.1m due within 12 months, and liabilities of HK$63.6m due beyond 12 months. Offsetting this, it had HK$33.9m in cash and HK$156.9m in receivables that were due within 12 months. So it has liabilities totalling HK$83.0m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Unity Group Holdings International has a market capitalization of HK$288.7m, 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Unity Group Holdings International'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, Unity Group Holdings International made a loss at the EBIT level, and saw its revenue drop to HK$47m, which is a fall of 37%. To be frank that doesn't bode well.

Caveat Emptor

While Unity Group Holdings International'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 HK$26m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled HK$24m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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 example Unity Group Holdings International has 3 warning signs (and 2 which are a bit unpleasant) 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. 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.