Kam Hing International Holdings (HKG:2307) Has A Somewhat Strained Balance Sheet

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.' 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 Kam Hing International Holdings Limited (HKG:2307) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Kam Hing International Holdings

What Is Kam Hing International Holdings's Net Debt?

As you can see below, at the end of June 2021, Kam Hing International Holdings had HK$1.83b of debt, up from HK$1.66b a year ago. Click the image for more detail. However, it also had HK$779.5m in cash, and so its net debt is HK$1.05b.

How Strong Is Kam Hing International Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kam Hing International Holdings had liabilities of HK$2.06b due within 12 months and liabilities of HK$683.7m due beyond that. Offsetting these obligations, it had cash of HK$779.5m as well as receivables valued at HK$749.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$1.21b.

This deficit casts a shadow over the HK$404.5m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Kam Hing International Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Kam Hing International Holdings's debt is 2.5 times its EBITDA, and its EBIT cover its interest expense 3.7 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. One redeeming factor for Kam Hing International Holdings is that it turned last year's EBIT loss into a gain of HK$123m, over the last twelve months. 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 Kam Hing 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Looking at the most recent year, Kam Hing International Holdings recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

We'd go so far as to say Kam Hing International Holdings's level of total liabilities was disappointing. But at least its conversion of EBIT to free cash flow is not so bad. We're quite clear that we consider Kam Hing International Holdings to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for Kam Hing International Holdings (2 are potentially serious!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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