Is New Concepts Holdings (HKG:2221) Using Debt In A Risky Way?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies New Concepts Holdings Limited (HKG:2221) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for New Concepts Holdings

What Is New Concepts Holdings's Debt?

The image below, which you can click on for greater detail, shows that New Concepts Holdings had debt of HK$534.7m at the end of September 2020, a reduction from HK$760.6m over a year. However, it does have HK$39.8m in cash offsetting this, leading to net debt of about HK$494.9m.

A Look At New Concepts Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that New Concepts Holdings had liabilities of HK$518.7m due within 12 months and liabilities of HK$403.3m due beyond that. Offsetting this, it had HK$39.8m in cash and HK$236.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$645.5m.

The deficiency here weighs heavily on the HK$141.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, New Concepts Holdings would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is New Concepts Holdings'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, New Concepts Holdings made a loss at the EBIT level, and saw its revenue drop to HK$790m, which is a fall of 13%. That's not what we would hope to see.

Caveat Emptor

While New Concepts Holdings'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 a very considerable HK$153m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost HK$280m in just last twelve months, and it doesn't have much by way of liquid assets. So while it's not wise to assume the company will fail, we do think it's risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for New Concepts Holdings (1 is potentially serious) you should be aware of.

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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