Would Paradise Entertainment (HKG:1180) Be Better Off With Less Debt?

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. Importantly, Paradise Entertainment Limited (HKG:1180) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Paradise Entertainment

What Is Paradise Entertainment's Debt?

The image below, which you can click on for greater detail, shows that Paradise Entertainment had debt of HK$138.6m at the end of December 2020, a reduction from HK$147.9m over a year. On the flip side, it has HK$129.2m in cash leading to net debt of about HK$9.37m.

A Look At Paradise Entertainment's Liabilities

The latest balance sheet data shows that Paradise Entertainment had liabilities of HK$121.4m due within a year, and liabilities of HK$133.0m falling due after that. On the other hand, it had cash of HK$129.2m and HK$55.9m worth of receivables due within a year. So its liabilities total HK$69.2m more than the combination of its cash and short-term receivables.

Of course, Paradise Entertainment has a market capitalization of HK$1.46b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, Paradise Entertainment has a very light debt load indeed. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Paradise Entertainment 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.

Over 12 months, Paradise Entertainment made a loss at the EBIT level, and saw its revenue drop to HK$352m, which is a fall of 70%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Paradise Entertainment's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping HK$240m. 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. Another cause for caution is that is bled HK$87m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Paradise Entertainment has 1 warning sign we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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