Narnia (Hong Kong) Group (HKG:8607) Is Carrying A Fair Bit Of Debt

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. As with many other companies Narnia (Hong Kong) Group Company Limited (HKG:8607) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Narnia (Hong Kong) Group

How Much Debt Does Narnia (Hong Kong) Group Carry?

The image below, which you can click on for greater detail, shows that Narnia (Hong Kong) Group had debt of CN¥96.5m at the end of December 2020, a reduction from CN¥106.4m over a year. On the flip side, it has CN¥10.1m in cash leading to net debt of about CN¥86.4m.

How Strong Is Narnia (Hong Kong) Group's Balance Sheet?

According to the last reported balance sheet, Narnia (Hong Kong) Group had liabilities of CN¥165.1m due within 12 months, and liabilities of CN¥15.9m due beyond 12 months. On the other hand, it had cash of CN¥10.1m and CN¥60.3m worth of receivables due within a year. So its liabilities total CN¥110.7m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥165.0m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Narnia (Hong Kong) Group 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 Narnia (Hong Kong) Group wasn't profitable at an EBIT level, but managed to grow its revenue by 3.5%, to CN¥314m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Narnia (Hong Kong) Group produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥1.7m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of CN¥6.2m. In the meantime, we consider the stock very 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. We've identified 3 warning signs with Narnia (Hong Kong) Group (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

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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