Is Wan Kei Group Holdings (HKG:1718) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Wan Kei Group Holdings Limited (HKG:1718) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Wan Kei Group Holdings

How Much Debt Does Wan Kei Group Holdings Carry?

The image below, which you can click on for greater detail, shows that at March 2021 Wan Kei Group Holdings had debt of HK$231.0m, up from HK$214.8m in one year. However, it also had HK$225.9m in cash, and so its net debt is HK$5.06m.

How Strong Is Wan Kei Group Holdings' Balance Sheet?

The latest balance sheet data shows that Wan Kei Group Holdings had liabilities of HK$281.4m due within a year, and liabilities of HK$4.38m falling due after that. Offsetting these obligations, it had cash of HK$225.9m as well as receivables valued at HK$190.8m due within 12 months. So it actually has HK$131.0m more liquid assets than total liabilities.

This surplus liquidity suggests that Wan Kei Group Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Wan Kei Group Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Wan Kei Group Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 15%, to HK$294m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Wan Kei Group Holdings had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost HK$11m at the EBIT level. That said, we're impressed with the strong balance sheet liquidity. That should give the business time to grow its cashflow. While the stock is probably a bit risky, there may be an opportunity if the business itself improves, allowing the company to stage a recovery. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Wan Kei Group Holdings (of which 1 is potentially serious!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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