Is Best Food Holding (HKG:1488) Using Debt In A Risky Way?

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.' 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. Importantly, Best Food Holding Company Limited (HKG:1488) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out the opportunities and risks within the HK Hospitality industry.

What Is Best Food Holding's Net Debt?

As you can see below, at the end of June 2022, Best Food Holding had CN¥558.9m of debt, up from CN¥529.9m a year ago. Click the image for more detail. On the flip side, it has CN¥103.9m in cash leading to net debt of about CN¥455.0m.

How Healthy Is Best Food Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Best Food Holding had liabilities of CN¥406.1m due within 12 months and liabilities of CN¥756.2m due beyond that. Offsetting this, it had CN¥103.9m in cash and CN¥73.5m in receivables that were due within 12 months. So it has liabilities totalling CN¥984.8m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥996.5m, so it does suggest shareholders should keep an eye on Best Food Holding's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Best Food Holding will need earnings to service that debt. 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, Best Food Holding made a loss at the EBIT level, and saw its revenue drop to CN¥660m, which is a fall of 16%. We would much prefer see growth.

Caveat Emptor

Not only did Best Food Holding's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥80m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of CN¥746m. So to be blunt we do think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Best Food Holding , and understanding them should be part of your investment process.

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.