Here's Why Kaisa Capital Investment Holdings (HKG:936) Has A Meaningful Debt Burden

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Kaisa Capital Investment Holdings Limited (HKG:936) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that 936 is potentially undervalued!

What Is Kaisa Capital Investment Holdings's Debt?

The image below, which you can click on for greater detail, shows that Kaisa Capital Investment Holdings had debt of HK$145.8m at the end of June 2022, a reduction from HK$199.4m over a year. However, because it has a cash reserve of HK$25.6m, its net debt is less, at about HK$120.3m.

How Healthy Is Kaisa Capital Investment Holdings' Balance Sheet?

According to the last reported balance sheet, Kaisa Capital Investment Holdings had liabilities of HK$298.0m due within 12 months, and liabilities of HK$85.1m due beyond 12 months. Offsetting these obligations, it had cash of HK$25.6m as well as receivables valued at HK$41.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$316.3m.

This is a mountain of leverage relative to its market capitalization of HK$360.4m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Kaisa Capital Investment Holdings has a quite reasonable net debt to EBITDA multiple of 2.3, its interest cover seems weak, at 1.7. In large part that's it has so much depreciation and amortisation. These charges may be non-cash, so they could be excluded when it comes to paying down debt. But the accounting charges are there for a reason -- some assets are seen to be losing value. In any case, it's safe to say the company has meaningful debt. We also note that Kaisa Capital Investment Holdings improved its EBIT from a last year's loss to a positive HK$15m. There's no doubt that we learn most about debt from the balance sheet. But it is Kaisa Capital Investment 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Kaisa Capital Investment Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Neither Kaisa Capital Investment Holdings's ability to cover its interest expense with its EBIT nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Looking at all the angles mentioned above, it does seem to us that Kaisa Capital Investment Holdings is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Kaisa Capital Investment Holdings (including 1 which makes us a bit uncomfortable) .

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.