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

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. Importantly, Glory Flame Holdings Limited (HKG:8059) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Glory Flame Holdings

How Much Debt Does Glory Flame Holdings Carry?

The image below, which you can click on for greater detail, shows that at June 2021 Glory Flame Holdings had debt of HK$75.4m, up from HK$64.3m in one year. However, it does have HK$42.2m in cash offsetting this, leading to net debt of about HK$33.2m.

A Look At Glory Flame Holdings' Liabilities

The latest balance sheet data shows that Glory Flame Holdings had liabilities of HK$97.8m due within a year, and liabilities of HK$9.29m falling due after that. Offsetting this, it had HK$42.2m in cash and HK$42.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$22.5m.

This deficit is considerable relative to its market capitalization of HK$31.3m, so it does suggest shareholders should keep an eye on Glory Flame Holdings' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Glory Flame 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.

In the last year Glory Flame Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 31%, to HK$102m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Even though Glory Flame Holdings managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping HK$4.4m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of HK$12m into a profit. So in short it's a really risky stock. 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. Be aware that Glory Flame Holdings is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

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.