Is AV Promotions Holdings (HKG:8419) 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.' 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. Importantly, AV Promotions Holdings Limited (HKG:8419) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for AV Promotions Holdings

What Is AV Promotions Holdings's Debt?

The chart below, which you can click on for greater detail, shows that AV Promotions Holdings had HK$96.6m in debt in December 2022; about the same as the year before. However, it does have HK$12.9m in cash offsetting this, leading to net debt of about HK$83.8m.

A Look At AV Promotions Holdings' Liabilities

We can see from the most recent balance sheet that AV Promotions Holdings had liabilities of HK$154.1m falling due within a year, and liabilities of HK$20.8m due beyond that. On the other hand, it had cash of HK$12.9m and HK$58.5m worth of receivables due within a year. So its liabilities total HK$103.5m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$63.6m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, AV Promotions Holdings would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since AV Promotions Holdings 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 AV Promotions Holdings had a loss before interest and tax, and actually shrunk its revenue by 43%, to HK$94m. To be frank that doesn't bode well.

Caveat Emptor

While AV Promotions Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping HK$52m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of HK$54m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. 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 AV Promotions Holdings (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.