Is Daido Group (HKG:544) Using Debt In A Risky Way?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Daido Group Limited (HKG:544) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Daido Group

How Much Debt Does Daido Group Carry?

The chart below, which you can click on for greater detail, shows that Daido Group had HK$135.0m in debt in December 2021; about the same as the year before. However, it also had HK$59.9m in cash, and so its net debt is HK$75.1m.

How Healthy Is Daido Group's Balance Sheet?

The latest balance sheet data shows that Daido Group had liabilities of HK$106.9m due within a year, and liabilities of HK$204.0m falling due after that. On the other hand, it had cash of HK$59.9m and HK$71.1m worth of receivables due within a year. So its liabilities total HK$179.9m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$54.5m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Daido Group would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Daido Group 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 Daido Group had a loss before interest and tax, and actually shrunk its revenue by 7.7%, to HK$235m. We would much prefer see growth.

Caveat Emptor

Importantly, Daido Group had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$26m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of HK$80m in the last year. So we think this stock is quite risky. We'd prefer to pass. 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. Be aware that Daido Group is showing 3 warning signs in our investment analysis , and 2 of those are concerning...

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.