Health Check: How Prudently Does Kai Yuan Holdings (HKG:1215) Use 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. We can see that Kai Yuan Holdings Limited (HKG:1215) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Kai Yuan Holdings

What Is Kai Yuan Holdings's Net Debt?

As you can see below, Kai Yuan Holdings had HK$1.52b of debt at December 2021, down from HK$1.64b a year prior. However, because it has a cash reserve of HK$871.7m, its net debt is less, at about HK$647.2m.

A Look At Kai Yuan Holdings' Liabilities

We can see from the most recent balance sheet that Kai Yuan Holdings had liabilities of HK$64.2m falling due within a year, and liabilities of HK$1.67b due beyond that. Offsetting these obligations, it had cash of HK$871.7m as well as receivables valued at HK$52.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$807.1m.

The deficiency here weighs heavily on the HK$370.6m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Kai Yuan Holdings would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is Kai Yuan 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.

Over 12 months, Kai Yuan Holdings reported revenue of HK$94m, which is a gain of 149%, although it did not report any earnings before interest and tax. So its pretty obvious shareholders are hoping for more growth!

Caveat Emptor

Despite the top line growth, Kai Yuan Holdings still had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$76m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of HK$164m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. 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. Case in point: We've spotted 2 warning signs for Kai Yuan Holdings you should be aware of, and 1 of them doesn't sit too well with us.

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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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.