Is Crocodile Garments (HKG:122) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Crocodile Garments Limited (HKG:122) 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, 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.

Check out our latest analysis for Crocodile Garments

What Is Crocodile Garments's Debt?

The image below, which you can click on for greater detail, shows that Crocodile Garments had debt of HK$745.5m at the end of January 2024, a reduction from HK$790.2m over a year. However, it does have HK$320.7m in cash offsetting this, leading to net debt of about HK$424.9m.

A Look At Crocodile Garments' Liabilities

We can see from the most recent balance sheet that Crocodile Garments had liabilities of HK$253.6m falling due within a year, and liabilities of HK$586.7m due beyond that. Offsetting these obligations, it had cash of HK$320.7m as well as receivables valued at HK$7.75m due within 12 months. So its liabilities total HK$511.9m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$149.2m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Crocodile Garments 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 Crocodile Garments 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, Crocodile Garments reported revenue of HK$94m, which is a gain of 16%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Crocodile Garments produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable HK$22m at the EBIT level. 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, given it is low on liquid assets, and burned through HK$17m in the last year. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Crocodile Garments is showing 2 warning signs in our investment analysis , and 1 of those is 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.

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