Kin Yat Holdings (HKG:638) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, '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. We can see that Kin Yat Holdings Limited (HKG:638) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

View our latest analysis for Kin Yat Holdings

What Is Kin Yat Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Kin Yat Holdings had debt of HK$657.4m at the end of September 2020, a reduction from HK$705.5m over a year. However, because it has a cash reserve of HK$332.5m, its net debt is less, at about HK$324.9m.

How Healthy Is Kin Yat Holdings' Balance Sheet?

We can see from the most recent balance sheet that Kin Yat Holdings had liabilities of HK$1.38b falling due within a year, and liabilities of HK$315.7m due beyond that. On the other hand, it had cash of HK$332.5m and HK$463.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$904.6m.

This deficit casts a shadow over the HK$526.8m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Kin Yat Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Kin Yat Holdings has a low net debt to EBITDA ratio of only 1.4. And its EBIT covers its interest expense a whopping 11.2 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, Kin Yat Holdings grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Kin Yat 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Kin Yat Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Kin Yat Holdings's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, we think it's fair to say that Kin Yat Holdings has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. Case in point: We've spotted 4 warning signs for Kin Yat Holdings you should be aware of, and 1 of them is a bit concerning.

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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