Is Kwan Yong Holdings (HKG:9998) Weighed On By Its Debt Load?

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. We can see that Kwan Yong Holdings Limited (HKG:9998) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Kwan Yong Holdings

How Much Debt Does Kwan Yong Holdings Carry?

As you can see below, at the end of December 2020, Kwan Yong Holdings had S$6.07m of debt, up from S$2.26m a year ago. Click the image for more detail. But on the other hand it also has S$41.5m in cash, leading to a S$35.5m net cash position.

How Strong Is Kwan Yong Holdings' Balance Sheet?

The latest balance sheet data shows that Kwan Yong Holdings had liabilities of S$54.8m due within a year, and liabilities of S$5.74m falling due after that. On the other hand, it had cash of S$41.5m and S$27.5m worth of receivables due within a year. So it actually has S$8.58m more liquid assets than total liabilities.

This surplus strongly suggests that Kwan Yong Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Kwan Yong Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Kwan Yong 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, Kwan Yong Holdings made a loss at the EBIT level, and saw its revenue drop to S$68m, which is a fall of 61%. To be frank that doesn't bode well.

So How Risky Is Kwan Yong Holdings?

While Kwan Yong Holdings lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow S$9.0m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. 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. We've identified 3 warning signs with Kwan Yong Holdings (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

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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