Health Check: How Prudently Does Future Bright Holdings (HKG:703) Use 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.' 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 note that Future Bright Holdings Limited (HKG:703) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Future Bright Holdings

What Is Future Bright Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Future Bright Holdings had HK$391.2m of debt in December 2020, down from HK$438.1m, one year before. However, it also had HK$65.9m in cash, and so its net debt is HK$325.4m.

A Look At Future Bright Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Future Bright Holdings had liabilities of HK$344.2m due within 12 months and liabilities of HK$458.2m due beyond that. Offsetting these obligations, it had cash of HK$65.9m as well as receivables valued at HK$51.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$684.7m.

This deficit casts a shadow over the HK$129.1m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Future Bright Holdings would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Future Bright Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Future Bright Holdings made a loss at the EBIT level, and saw its revenue drop to HK$419m, which is a fall of 63%. That makes us nervous, to say the least.

Caveat Emptor

While Future Bright Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable HK$192m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost HK$121m in just last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is quite risky. We'd prefer to pass. 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. For example Future Bright Holdings has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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. 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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