Is Glory Flame Holdings (HKG:8059) Using Debt Sensibly?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Glory Flame Holdings Limited (HKG:8059) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Glory Flame Holdings

What Is Glory Flame Holdings's Net Debt?

The chart below, which you can click on for greater detail, shows that Glory Flame Holdings had HK$64.3m in debt in December 2021; about the same as the year before. However, it does have HK$37.1m in cash offsetting this, leading to net debt of about HK$27.1m.

How Strong Is Glory Flame Holdings' Balance Sheet?

The latest balance sheet data shows that Glory Flame Holdings had liabilities of HK$86.2m due within a year, and liabilities of HK$27.2m falling due after that. On the other hand, it had cash of HK$37.1m and HK$45.9m worth of receivables due within a year. So its liabilities total HK$30.3m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of HK$24.3m, we think shareholders really should watch Glory Flame Holdings's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Glory Flame 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.

In the last year Glory Flame Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 22%, to HK$99m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

While we can certainly appreciate Glory Flame Holdings's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable HK$10m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of HK$37m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Glory Flame Holdings (including 1 which doesn't sit too well with us) .

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.