Is Tai Kam Holdings (HKG:8321) Using Debt Sensibly?

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.' 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. We note that Tai Kam Holdings Limited (HKG:8321) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Tai Kam Holdings

How Much Debt Does Tai Kam Holdings Carry?

The chart below, which you can click on for greater detail, shows that Tai Kam Holdings had HK$13.9m in debt in October 2021; about the same as the year before. But it also has HK$28.5m in cash to offset that, meaning it has HK$14.7m net cash.

How Healthy Is Tai Kam Holdings' Balance Sheet?

According to the last reported balance sheet, Tai Kam Holdings had liabilities of HK$34.0m due within 12 months, and liabilities of HK$62.0k due beyond 12 months. On the other hand, it had cash of HK$28.5m and HK$94.0m worth of receivables due within a year. So it can boast HK$88.5m more liquid assets than total liabilities.

This surplus liquidity suggests that Tai Kam Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Tai Kam Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tai Kam Holdings will need earnings to service that debt. 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 11%, to HK$112m. We would much prefer see growth.

So How Risky Is Tai Kam Holdings?

Statistically speaking companies that lose money are riskier than those that make money. And in the last year Tai Kam Holdings had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of HK$13m and booked a HK$12m accounting loss. With only HK$14.7m on the balance sheet, it would appear that its going to need to raise capital again soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. For example Tai Kam Holdings has 3 warning signs (and 1 which is concerning) we think you should know about.

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.