Is Kai Yuan Holdings (HKG:1215) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Kai Yuan Holdings Limited (HKG:1215) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kai Yuan Holdings

How Much Debt Does Kai Yuan Holdings Carry?

The chart below, which you can click on for greater detail, shows that Kai Yuan Holdings had HK$1.49b in debt in June 2020; about the same as the year before. However, because it has a cash reserve of HK$1.03b, its net debt is less, at about HK$455.9m.

How Strong Is Kai Yuan Holdings's Balance Sheet?

We can see from the most recent balance sheet that Kai Yuan Holdings had liabilities of HK$1.53b falling due within a year, and liabilities of HK$232.2m due beyond that. Offsetting this, it had HK$1.03b in cash and HK$52.8m in receivables that were due within 12 months. So it has liabilities totalling HK$680.6m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's HK$511.2m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. 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 made a loss at the EBIT level, and saw its revenue drop to HK$169m, which is a fall of 38%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Kai Yuan Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost HK$45m at the EBIT level. 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. For example, we would not want to see a repeat of last year's loss of HK$50m. In the meantime, we consider the stock to be 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, we've discovered 1 warning sign for Kai Yuan Holdings that you should be aware of before investing here.

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. 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.
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