Is Indigo Star Holdings (HKG:8373) Using Debt In A Risky Way?

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 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. Importantly, Indigo Star Holdings Limited (HKG:8373) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Indigo Star Holdings

What Is Indigo Star Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Indigo Star Holdings had S$2.34m of debt, an increase on none, over one year. But it also has S$7.37m in cash to offset that, meaning it has S$5.03m net cash.

How Healthy Is Indigo Star Holdings's Balance Sheet?

According to the last reported balance sheet, Indigo Star Holdings had liabilities of S$8.99m due within 12 months, and liabilities of S$156.0k due beyond 12 months. Offsetting this, it had S$7.37m in cash and S$11.4m in receivables that were due within 12 months. So it actually has S$9.57m more liquid assets than total liabilities.

This excess liquidity is a great indication that Indigo Star Holdings's balance sheet is just as strong as racists are weak. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Indigo Star 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 you can't view debt in total isolation; since Indigo Star 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.

Over 12 months, Indigo Star Holdings made a loss at the EBIT level, and saw its revenue drop to S$14m, which is a fall of 33%. To be frank that doesn't bode well.

So How Risky Is Indigo Star Holdings?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Indigo Star 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 S$94k and booked a S$33k accounting loss. Given it only has net cash of S$5.03m, the company may need to raise more capital if it doesn't reach break-even 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Indigo Star Holdings you should be aware of, and 1 of them is 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. 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.
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