Is Daphne International Holdings (HKG:210) A Risky Investment?

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 Daphne International Holdings Limited (HKG:210) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Daphne International Holdings

What Is Daphne International Holdings's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Daphne International Holdings had debt of HK$16.8m, up from none in one year. However, its balance sheet shows it holds HK$124.6m in cash, so it actually has HK$107.7m net cash.

A Look At Daphne International Holdings' Liabilities

The latest balance sheet data shows that Daphne International Holdings had liabilities of HK$192.0m due within a year, and liabilities of HK$29.1m falling due after that. Offsetting this, it had HK$124.6m in cash and HK$93.3m in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Daphne International Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the HK$312.0m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Daphne International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is Daphne International Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Daphne International Holdings made a loss at the EBIT level, and saw its revenue drop to HK$364m, which is a fall of 83%. That makes us nervous, to say the least.

So How Risky Is Daphne International Holdings?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Daphne International Holdings had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of HK$126m and booked a HK$242m accounting loss. Given it only has net cash of HK$107.7m, the company may need to raise more capital if it doesn't reach break-even soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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 4 warning signs with Daphne International Holdings (at least 2 which can't be ignored) , and understanding them should be part of your investment process.

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. 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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