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. As with many other companies Eagle Legend Asia Limited (HKG:936) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Eagle Legend Asia's Net Debt?
The image below, which you can click on for greater detail, shows that Eagle Legend Asia had debt of HK$156.2m at the end of December 2020, a reduction from HK$236.9m over a year. However, it also had HK$30.0m in cash, and so its net debt is HK$126.2m.
How Strong Is Eagle Legend Asia's Balance Sheet?
The latest balance sheet data shows that Eagle Legend Asia had liabilities of HK$251.7m due within a year, and liabilities of HK$106.6m falling due after that. Offsetting this, it had HK$30.0m in cash and HK$64.2m in receivables that were due within 12 months. So it has liabilities totalling HK$264.2m more than its cash and near-term receivables, combined.
This deficit isn't so bad because Eagle Legend Asia is worth HK$561.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Eagle Legend Asia will need earnings to service that debt. 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 Eagle Legend Asia wasn't profitable at an EBIT level, but managed to grow its revenue by 15%, to HK$143m. We usually like to see faster growth from unprofitable companies, but each to their own.
Over the last twelve months Eagle Legend Asia produced an earnings before interest and tax (EBIT) loss. Indeed, it lost HK$51m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of HK$63m. So to be blunt we do think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Eagle Legend Asia you should be aware of, and 1 of them is a bit unpleasant.
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. 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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