Keck Seng Investments (Hong Kong) (HKG:184) Takes On Some Risk With Its Use Of 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.' 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, Keck Seng Investments (Hong Kong) Limited (HKG:184) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Keck Seng Investments (Hong Kong)

What Is Keck Seng Investments (Hong Kong)'s Net Debt?

As you can see below, Keck Seng Investments (Hong Kong) had HK$1.84b of debt, at June 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had HK$1.73b in cash, and so its net debt is HK$113.3m.

How Strong Is Keck Seng Investments (Hong Kong)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Keck Seng Investments (Hong Kong) had liabilities of HK$2.06b due within 12 months and liabilities of HK$232.5m due beyond that. On the other hand, it had cash of HK$1.73b and HK$97.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$469.4m.

This deficit isn't so bad because Keck Seng Investments (Hong Kong) is worth HK$1.20b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 0.50 and interest cover of 6.2 times, it seems to us that Keck Seng Investments (Hong Kong) is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. The modesty of its debt load may become crucial for Keck Seng Investments (Hong Kong) if management cannot prevent a repeat of the 81% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Keck Seng Investments (Hong Kong) 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Keck Seng Investments (Hong Kong) produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Keck Seng Investments (Hong Kong)'s struggle to grow its EBIT had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its net debt to EBITDA was refreshing. We think that Keck Seng Investments (Hong Kong)'s debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Keck Seng Investments (Hong Kong) has 2 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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