Is Century Legend (Holdings) (HKG:79) Using Debt Sensibly?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Century Legend (Holdings) Limited (HKG:79) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Century Legend (Holdings)

How Much Debt Does Century Legend (Holdings) Carry?

The chart below, which you can click on for greater detail, shows that Century Legend (Holdings) had HK$204.4m in debt in December 2020; about the same as the year before. However, because it has a cash reserve of HK$96.3m, its net debt is less, at about HK$108.1m.

How Strong Is Century Legend (Holdings)'s Balance Sheet?

According to the last reported balance sheet, Century Legend (Holdings) had liabilities of HK$225.3m due within 12 months, and liabilities of HK$25.0m due beyond 12 months. Offsetting this, it had HK$96.3m in cash and HK$8.19m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$145.8m.

This deficit casts a shadow over the HK$47.3m company, like a colossus towering over mere mortals. 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 it is Century Legend (Holdings)'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.

In the last year Century Legend (Holdings) wasn't profitable at an EBIT level, but managed to grow its revenue by 14%, to HK$35m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Century Legend (Holdings) produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable HK$17m 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$24m in just last twelve months, and it doesn't have much by way of liquid assets. So while it's not wise to assume the company will fail, we do think it's risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Century Legend (Holdings) (at least 2 which are a bit unpleasant) , and understanding them should be part of your investment process.

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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