Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Tai Kam Holdings Limited (HKG:8321) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Tai Kam Holdings
What Is Tai Kam Holdings's Net Debt?
As you can see below, Tai Kam Holdings had HK$14.0m of debt, at April 2022, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds HK$31.2m in cash, so it actually has HK$17.2m net cash.
How Strong Is Tai Kam Holdings' Balance Sheet?
We can see from the most recent balance sheet that Tai Kam Holdings had liabilities of HK$32.1m falling due within a year, and liabilities of HK$6.0k due beyond that. Offsetting this, it had HK$31.2m in cash and HK$76.3m in receivables that were due within 12 months. So it can boast HK$75.3m 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). 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. 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 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 Tai Kam Holdings had a loss before interest and tax, and actually shrunk its revenue by 58%, to HK$58m. To be frank that doesn't bode well.
So How Risky Is Tai Kam Holdings?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Tai Kam Holdings lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of HK$8.7m and booked a HK$19m accounting loss. Given it only has net cash of HK$17.2m, the company may need to raise more capital if it doesn't reach break-even 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Tai Kam Holdings has 4 warning signs (and 3 which make us uncomfortable) we think you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
About SEHK:8321
Tai Kam Holdings
An investment holding company, undertakes site formation works and renovation works in Hong Kong.
Flawless balance sheet low.