Is Continental Holdings (HKG:513) Using Debt In A Risky Way?

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. Importantly, Continental Holdings Limited (HKG:513) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Continental Holdings

What Is Continental Holdings's Debt?

As you can see below, Continental Holdings had HK$1.14b of debt, at December 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has HK$150.1m in cash leading to net debt of about HK$992.3m.

How Strong Is Continental Holdings' Balance Sheet?

We can see from the most recent balance sheet that Continental Holdings had liabilities of HK$1.26b falling due within a year, and liabilities of HK$202.1m due beyond that. Offsetting this, it had HK$150.1m in cash and HK$88.3m in receivables that were due within 12 months. So its liabilities total HK$1.23b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$266.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Continental Holdings would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Continental 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.

Over 12 months, Continental Holdings made a loss at the EBIT level, and saw its revenue drop to HK$538m, which is a fall of 7.6%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Continental Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable HK$82m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it vaporized HK$52m in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. 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. For instance, we've identified 4 warning signs for Continental Holdings (3 are significant) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.