Is Madison Holdings Group (HKG:8057) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Madison Holdings Group Limited (HKG:8057) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Madison Holdings Group

What Is Madison Holdings Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Madison Holdings Group had HK$370.9m of debt, an increase on HK$348.4m, over one year. However, it also had HK$62.6m in cash, and so its net debt is HK$308.3m.

How Healthy Is Madison Holdings Group's Balance Sheet?

According to the last reported balance sheet, Madison Holdings Group had liabilities of HK$431.8m due within 12 months, and liabilities of HK$10.4m due beyond 12 months. Offsetting this, it had HK$62.6m in cash and HK$472.6m in receivables that were due within 12 months. So it actually has HK$92.9m more liquid assets than total liabilities.

This excess liquidity suggests that Madison Holdings Group is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Madison Holdings Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Madison Holdings Group reported revenue of HK$130m, which is a gain of 22%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Madison Holdings Group's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost HK$14m 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 a profit would do more to inspire us to research the business more closely. This one is a bit too risky for our liking. 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. We've identified 2 warning signs with Madison Holdings Group , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.