Is Success Dragon International Holdings (HKG:1182) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Success Dragon International Holdings Limited (HKG:1182) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Success Dragon International Holdings

What Is Success Dragon International Holdings's Net Debt?

As you can see below, Success Dragon International Holdings had HK$13.4m of debt at September 2022, down from HK$33.1m a year prior. However, it does have HK$82.5m in cash offsetting this, leading to net cash of HK$69.0m.

How Strong Is Success Dragon International Holdings' Balance Sheet?

According to the balance sheet data, Success Dragon International Holdings had liabilities of HK$84.2m due within 12 months, but no longer term liabilities. Offsetting these obligations, it had cash of HK$82.5m as well as receivables valued at HK$31.0m due within 12 months. So it can boast HK$29.2m more liquid assets than total liabilities.

This surplus suggests that Success Dragon International Holdings is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Success Dragon International Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Success Dragon 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.

In the last year Success Dragon International Holdings had a loss before interest and tax, and actually shrunk its revenue by 30%, to HK$162m. That makes us nervous, to say the least.

So How Risky Is Success Dragon International Holdings?

Statistically speaking companies that lose money are riskier than those that make money. And in the last year Success Dragon International Holdings had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through HK$1.2m of cash and made a loss of HK$4.0m. Given it only has net cash of HK$69.0m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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. We've identified 2 warning signs with Success Dragon International Holdings (at least 1 which doesn't sit too well with us) , 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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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.