Is King's Flair International (Holdings) (HKG:6822) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that King's Flair International (Holdings) Limited (HKG:6822) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for King's Flair International (Holdings)

What Is King's Flair International (Holdings)'s Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 King's Flair International (Holdings) had debt of HK$61.4m, up from HK$58.4m in one year. However, it does have HK$409.4m in cash offsetting this, leading to net cash of HK$348.0m.

A Look At King's Flair International (Holdings)'s Liabilities

The latest balance sheet data shows that King's Flair International (Holdings) had liabilities of HK$211.4m due within a year, and liabilities of HK$5.67m falling due after that. Offsetting these obligations, it had cash of HK$409.4m as well as receivables valued at HK$265.2m due within 12 months. So it actually has HK$457.5m more liquid assets than total liabilities.

This luscious liquidity implies that King's Flair International (Holdings)'s balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, King's Flair International (Holdings) boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that King's Flair International (Holdings) saw its EBIT decline by 2.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is King's Flair International (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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While King's Flair 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. Over the most recent three years, King's Flair International (Holdings) recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case King's Flair International (Holdings) has HK$348.0m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 75% of that EBIT to free cash flow, bringing in HK$102m. So we don't think King's Flair International (Holdings)'s use of debt is risky. 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. Case in point: We've spotted 2 warning signs for King's Flair International (Holdings) you should be aware of, and 1 of them is potentially serious.

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.

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