Health Check: How Prudently Does Century Legend (Holdings) (HKG:79) Use Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Century Legend (Holdings) Limited (HKG:79) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Century Legend (Holdings)

What Is Century Legend (Holdings)'s Debt?

The chart below, which you can click on for greater detail, shows that Century Legend (Holdings) had HK$204.7m in debt in June 2020; about the same as the year before. On the flip side, it has HK$82.5m in cash leading to net debt of about HK$122.2m.

A Look At Century Legend (Holdings)'s Liabilities

According to the last reported balance sheet, Century Legend (Holdings) had liabilities of HK$209.3m due within 12 months, and liabilities of HK$23.5m due beyond 12 months. Offsetting this, it had HK$82.5m in cash and HK$7.42m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$142.9m.

The deficiency here weighs heavily on the HK$50.9m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Century Legend (Holdings) would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Century Legend (Holdings) 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.

In the last year Century Legend (Holdings) wasn't profitable at an EBIT level, but managed to grow its revenue by 27%, to HK$33m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Century Legend (Holdings) still had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$17m. 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$50m 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, we've discovered 4 warning signs for Century Legend (Holdings) (2 are a bit concerning!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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