Health Check: How Prudently Does Tai Kam Holdings (HKG:8321) Use Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Tai Kam Holdings Limited (HKG:8321) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Tai Kam Holdings

What Is Tai Kam Holdings's Debt?

The chart below, which you can click on for greater detail, shows that Tai Kam Holdings had HK$14.1m in debt in October 2022; about the same as the year before. But on the other hand it also has HK$35.0m in cash, leading to a HK$20.8m net cash position.

How Healthy Is Tai Kam Holdings' Balance Sheet?

According to the balance sheet data, Tai Kam Holdings had liabilities of HK$34.1m due within 12 months, but no longer term liabilities. Offsetting these obligations, it had cash of HK$35.0m as well as receivables valued at HK$58.6m due within 12 months. So it actually has HK$59.5m more liquid assets than total liabilities.

This surplus strongly suggests that Tai Kam Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Tai Kam Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is Tai Kam 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.

In the last year Tai Kam Holdings had a loss before interest and tax, and actually shrunk its revenue by 27%, to HK$81m. That makes us nervous, to say the least.

So How Risky Is Tai Kam Holdings?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Tai Kam Holdings had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of HK$5.1m and booked a HK$24m accounting loss. With only HK$20.8m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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. Case in point: We've spotted 4 warning signs for Tai Kam Holdings you should be aware of, and 3 of them are potentially serious.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.