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

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. 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?

Why Does Debt Bring Risk?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Century Legend (Holdings)

What Is Century Legend (Holdings)'s Debt?

As you can see below, Century Legend (Holdings) had HK$203.1m of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has HK$92.9m in cash leading to net debt of about HK$110.2m.

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

According to the last reported balance sheet, Century Legend (Holdings) had liabilities of HK$223.6m due within 12 months, and liabilities of HK$21.0m due beyond 12 months. On the other hand, it had cash of HK$92.9m and HK$6.00m worth of receivables due within a year. So its liabilities total HK$145.7m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$65.2m 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 definitely think shareholders need to watch this one closely. After all, Century Legend (Holdings) would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Century Legend (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.

In the last year Century Legend (Holdings) wasn't profitable at an EBIT level, but managed to grow its revenue by 13%, to HK$38m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Century Legend (Holdings) had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$15m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of HK$1.1m and the profit of HK$3.1m. So one might argue that there's still a chance it can get things on the right track. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 5 warning signs for Century Legend (Holdings) you should be aware of, and 2 of them are a bit unpleasant.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.
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