Is MS Concept (HKG:8447) Using Debt In A Risky Way?

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. We note that MS Concept Limited (HKG:8447) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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 MS Concept

What Is MS Concept's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 MS Concept had HK$78.9m of debt, an increase on HK$7.33m, over one year. However, it does have HK$56.7m in cash offsetting this, leading to net debt of about HK$22.2m.

How Strong Is MS Concept's Balance Sheet?

We can see from the most recent balance sheet that MS Concept had liabilities of HK$68.3m falling due within a year, and liabilities of HK$40.9m due beyond that. Offsetting these obligations, it had cash of HK$56.7m as well as receivables valued at HK$892.0k due within 12 months. So its liabilities total HK$51.6m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of HK$53.0m, so it does suggest shareholders should keep an eye on MS Concept's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since MS Concept 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.

Over 12 months, MS Concept made a loss at the EBIT level, and saw its revenue drop to HK$208m, which is a fall of 7.2%. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months MS Concept produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping HK$6.2m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of HK$440k into a profit. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for MS Concept (of which 2 are significant!) 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. 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.