Is EDICO Holdings (HKG:8450) Using Debt Sensibly?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 EDICO Holdings Limited (HKG:8450) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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

See our latest analysis for EDICO Holdings

What Is EDICO Holdings's Net Debt?

As you can see below, at the end of March 2022, EDICO Holdings had HK$23.9m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds HK$62.4m in cash, so it actually has HK$38.5m net cash.

How Strong Is EDICO Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that EDICO Holdings had liabilities of HK$23.7m due within 12 months and liabilities of HK$15.4m due beyond that. Offsetting these obligations, it had cash of HK$62.4m as well as receivables valued at HK$8.74m due within 12 months. So it can boast HK$32.0m more liquid assets than total liabilities.

This luscious liquidity implies that EDICO Holdings' balance sheet is sturdy like a giant sequoia tree. 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 EDICO Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since EDICO 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.

In the last year EDICO Holdings had a loss before interest and tax, and actually shrunk its revenue by 23%, to HK$49m. That makes us nervous, to say the least.

So How Risky Is EDICO Holdings?

While EDICO Holdings lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow HK$9.2m. 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. The next few years will be important as the business matures. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for EDICO Holdings you should be aware of.

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.