Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Kiddieland International Limited (HKG:3830) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Kiddieland International Carry?
You can click the graphic below for the historical numbers, but it shows that Kiddieland International had HK$16.2m of debt in October 2021, down from HK$22.7m, one year before. On the flip side, it has HK$13.0m in cash leading to net debt of about HK$3.16m.
A Look At Kiddieland International's Liabilities
We can see from the most recent balance sheet that Kiddieland International had liabilities of HK$54.1m falling due within a year, and liabilities of HK$1.70m due beyond that. Offsetting this, it had HK$13.0m in cash and HK$60.9m in receivables that were due within 12 months. So it can boast HK$18.1m more liquid assets than total liabilities.
This short term liquidity is a sign that Kiddieland International could probably pay off its debt with ease, as its balance sheet is far from stretched. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Kiddieland International 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.
In the last year Kiddieland International had a loss before interest and tax, and actually shrunk its revenue by 11%, to HK$251m. We would much prefer see growth.
Not only did Kiddieland International's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost HK$16m at the EBIT level. Looking on the brighter side, the business has adequate liquid assets, which give it time to grow and develop before its debt becomes a near-term issue. But we'd be more likely to spend time trying to understand the stock if the company made a profit. So it seems too risky for our taste. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Kiddieland International is showing 1 warning sign in our investment analysis , 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.