K. H. Group Holdings (HKG:1557) Has No Shortage Of 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that K. H. Group Holdings Limited (HKG:1557) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for K. H. Group Holdings

What Is K. H. Group Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2021 K. H. Group Holdings had debt of HK$190.0m, up from HK$142.6m in one year. However, it also had HK$9.46m in cash, and so its net debt is HK$180.6m.

How Healthy Is K. H. Group Holdings' Balance Sheet?

We can see from the most recent balance sheet that K. H. Group Holdings had liabilities of HK$494.6m falling due within a year, and liabilities of HK$94.8m due beyond that. On the other hand, it had cash of HK$9.46m and HK$420.3m worth of receivables due within a year. So its liabilities total HK$159.7m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since K. H. Group Holdings has a market capitalization of HK$280.0m, 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

K. H. Group Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (28.1), and fairly weak interest coverage, since EBIT is just 0.27 times the interest expense. This means we'd consider it to have a heavy debt load. Worse, K. H. Group Holdings's EBIT was down 64% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is K. H. 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. So we always check how much of that EBIT is translated into free cash flow. During the last two years, K. H. Group Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, K. H. Group 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. And furthermore, its net debt to EBITDA also fails to instill confidence. After considering the datapoints discussed, we think K. H. Group Holdings has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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 instance, we've identified 5 warning signs for K. H. Group Holdings (2 are significant) you should be aware of.

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.
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