These 4 Measures Indicate That Daphne International Holdings (HKG:210) Is Using Debt Safely

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 note that Daphne International Holdings Limited (HKG:210) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that 210 is potentially undervalued!

What Is Daphne International Holdings's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Daphne International Holdings had debt of HK$30.5m, up from HK$25.0m in one year. But it also has HK$226.4m in cash to offset that, meaning it has HK$195.9m net cash.

How Healthy Is Daphne International Holdings' Balance Sheet?

The latest balance sheet data shows that Daphne International Holdings had liabilities of HK$103.6m due within a year, and liabilities of HK$37.7m falling due after that. On the other hand, it had cash of HK$226.4m and HK$36.9m worth of receivables due within a year. So it can boast HK$121.9m more liquid assets than total liabilities.

This surplus liquidity suggests that Daphne International Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Daphne International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Daphne International Holdings turned things around in the last 12 months, delivering and EBIT of HK$40m. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Daphne International Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Daphne International Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Daphne International Holdings has HK$195.9m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 216% of that EBIT to free cash flow, bringing in HK$85m. So we don't think Daphne International Holdings's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Daphne International Holdings you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.