We Think Keck Seng Investments (Hong Kong) (HKG:184) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Keck Seng Investments (Hong Kong) Limited (HKG:184) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Keck Seng Investments (Hong Kong)

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

As you can see below, Keck Seng Investments (Hong Kong) had HK$1.55b of debt, at June 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have HK$1.37b in cash offsetting this, leading to net debt of about HK$181.6m.

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

The latest balance sheet data shows that Keck Seng Investments (Hong Kong) had liabilities of HK$1.79b due within a year, and liabilities of HK$275.9m falling due after that. Offsetting these obligations, it had cash of HK$1.37b as well as receivables valued at HK$87.9m due within 12 months. So it has liabilities totalling HK$611.7m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of HK$697.4m, so it does suggest shareholders should keep an eye on Keck Seng Investments (Hong Kong)'s use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Keck Seng Investments (Hong Kong)'s low debt to EBITDA ratio of 0.56 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.9 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. It was also good to see that despite losing money on the EBIT line last year, Keck Seng Investments (Hong Kong) turned things around in the last 12 months, delivering and EBIT of HK$182m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Keck Seng Investments (Hong Kong)'s earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Keck Seng Investments (Hong Kong) actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

When it comes to the balance sheet, the standout positive for Keck Seng Investments (Hong Kong) was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to handle its total liabilities. When we consider all the elements mentioned above, it seems to us that Keck Seng Investments (Hong Kong) is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. To that end, you should learn about the 2 warning signs we've spotted with Keck Seng Investments (Hong Kong) (including 1 which makes us a bit uncomfortable) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.