Build King Holdings (HKG:240) Seems To Use Debt Rather Sparingly

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.' 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 Build King Holdings Limited (HKG:240) makes use of debt. But should shareholders be worried about its use of debt?

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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Build King Holdings

What Is Build King Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Build King Holdings had HK$319.9m of debt, an increase on HK$301.1m, over one year. However, its balance sheet shows it holds HK$1.73b in cash, so it actually has HK$1.41b net cash.

A Look At Build King Holdings's Liabilities

We can see from the most recent balance sheet that Build King Holdings had liabilities of HK$3.42b falling due within a year, and liabilities of HK$36.7m due beyond that. Offsetting these obligations, it had cash of HK$1.73b as well as receivables valued at HK$2.22b due within 12 months. So it actually has HK$496.5m more liquid assets than total liabilities.

This surplus liquidity suggests that Build King Holdings's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Succinctly put, Build King Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Build King Holdings saw its EBIT drop by 5.8% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Build King Holdings will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Build King Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Build King Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Build King Holdings has HK$1.41b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of -HK$310m, being 104% of its EBIT. So we don't think Build King Holdings's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Build King Holdings .

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. 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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