Here's Why Paradise Entertainment (HKG:1180) Can Afford Some Debt

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. Importantly, Paradise Entertainment Limited (HKG:1180) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Paradise Entertainment

What Is Paradise Entertainment's Net Debt?

The image below, which you can click on for greater detail, shows that Paradise Entertainment had debt of HK$131.4m at the end of December 2021, a reduction from HK$138.6m over a year. However, it also had HK$64.0m in cash, and so its net debt is HK$67.3m.

How Strong Is Paradise Entertainment's Balance Sheet?

We can see from the most recent balance sheet that Paradise Entertainment had liabilities of HK$101.4m falling due within a year, and liabilities of HK$130.8m due beyond that. On the other hand, it had cash of HK$64.0m and HK$41.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$127.1m.

Of course, Paradise Entertainment has a market capitalization of HK$820.7m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Paradise Entertainment's earnings that will influence how the balance sheet holds up in the future. 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, Paradise Entertainment reported revenue of HK$494m, which is a gain of 40%, 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

Despite the top line growth, Paradise Entertainment still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at HK$81m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much 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 HK$86m. So we do think this stock is quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Paradise Entertainment is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

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.