Is KFM Kingdom Holdings (HKG:3816) 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. As with many other companies KFM Kingdom Holdings Limited (HKG:3816) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for KFM Kingdom Holdings

What Is KFM Kingdom Holdings's Net Debt?

As you can see below, KFM Kingdom Holdings had HK$166.0m of debt at September 2020, down from HK$210.0m a year prior. But it also has HK$402.3m in cash to offset that, meaning it has HK$236.3m net cash.

How Strong Is KFM Kingdom Holdings' Balance Sheet?

The latest balance sheet data shows that KFM Kingdom Holdings had liabilities of HK$304.6m due within a year, and liabilities of HK$7.27m falling due after that. Offsetting this, it had HK$402.3m in cash and HK$178.3m in receivables that were due within 12 months. So it can boast HK$268.8m more liquid assets than total liabilities.

This surplus strongly suggests that KFM Kingdom Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that KFM Kingdom Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

We note that KFM Kingdom Holdings grew its EBIT by 29% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is KFM Kingdom 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While KFM Kingdom 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. Over the last three years, KFM Kingdom Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, the bottom line is that KFM Kingdom Holdings has net cash of HK$236.3m and plenty of liquid assets. And it impressed us with free cash flow of HK$76m, being 132% of its EBIT. When it comes to KFM Kingdom Holdings's debt, we sufficiently relaxed that our mind turns to the jacuzzi. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for KFM Kingdom Holdings that 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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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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