Is Affluent Foundation Holdings (HKG:1757) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Affluent Foundation Holdings Limited (HKG:1757) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Affluent Foundation Holdings

What Is Affluent Foundation Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Affluent Foundation Holdings had debt of HK$38.3m at the end of September 2020, a reduction from HK$43.3m over a year. However, because it has a cash reserve of HK$15.9m, its net debt is less, at about HK$22.4m.

A Look At Affluent Foundation Holdings's Liabilities

According to the last reported balance sheet, Affluent Foundation Holdings had liabilities of HK$126.7m due within 12 months, and liabilities of HK$4.67m due beyond 12 months. Offsetting these obligations, it had cash of HK$15.9m as well as receivables valued at HK$150.6m due within 12 months. So it can boast HK$35.1m more liquid assets than total liabilities.

This surplus suggests that Affluent Foundation Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Affluent Foundation 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.

Over 12 months, Affluent Foundation Holdings made a loss at the EBIT level, and saw its revenue drop to HK$226m, which is a fall of 6.4%. We would much prefer see growth.

Caveat Emptor

Importantly, Affluent Foundation Holdings had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost HK$21m at the EBIT level. Looking on the brighter side, the business has adequate liquid assets, which give it time to grow and develop before its debt becomes a near-term issue. Still, we'd be more encouraged to study the business in depth if it already had some free cash flow. So it seems too risky for our taste. 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. For instance, we've identified 3 warning signs for Affluent Foundation Holdings (1 is potentially serious) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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