Herald Holdings (HKG:114) Has Debt But No Earnings; Should You Worry?

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 Herald Holdings Limited (HKG:114) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Herald Holdings

What Is Herald Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Herald Holdings had HK$54.0m of debt, an increase on HK$1.09m, over one year. However, it does have HK$118.8m in cash offsetting this, leading to net cash of HK$64.8m.

How Strong Is Herald Holdings' Balance Sheet?

According to the last reported balance sheet, Herald Holdings had liabilities of HK$294.1m due within 12 months, and liabilities of HK$47.6m due beyond 12 months. On the other hand, it had cash of HK$118.8m and HK$122.0m worth of receivables due within a year. So it has liabilities totalling HK$100.8m more than its cash and near-term receivables, combined.

Herald Holdings has a market capitalization of HK$259.9m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Herald Holdings also has more cash than debt, so we're pretty confident 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 Herald 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, Herald Holdings reported revenue of HK$1.2b, which is a gain of 27%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Herald Holdings?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Herald Holdings had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of HK$94m and booked a HK$61m accounting loss. With only HK$64.8m on the balance sheet, it would appear that its going to need to raise capital again soon. Herald Holdings's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Herald Holdings is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.