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

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 Daphne International Holdings Limited (HKG:210) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Daphne International Holdings

How Much Debt Does Daphne International Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Daphne International Holdings had HK$33.2m of debt, an increase on HK$30.5m, over one year. However, its balance sheet shows it holds HK$378.8m in cash, so it actually has HK$345.6m net cash.

A Look At Daphne International Holdings' Liabilities

The latest balance sheet data shows that Daphne International Holdings had liabilities of HK$147.1m due within a year, and liabilities of HK$6.54m falling due after that. Offsetting these obligations, it had cash of HK$378.8m as well as receivables valued at HK$24.9m due within 12 months. So it can boast HK$250.1m more liquid assets than total liabilities.

This surplus strongly suggests that Daphne International Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Daphne International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Daphne International Holdings grew its EBIT by 109% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Daphne International 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Daphne International Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Daphne International Holdings actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Daphne International Holdings has net cash of HK$345.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of HK$134m, being 179% of its EBIT. At the end of the day we're not concerned about Daphne International Holdings's debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Daphne International Holdings you should be aware of.

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.