Does Fameglow Holdings (HKG:8603) Have A Healthy Balance Sheet?

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.' 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. Importantly, Fameglow Holdings Limited (HKG:8603) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Fameglow Holdings

What Is Fameglow Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Fameglow Holdings had debt of HK$25.1m, up from HK$15.0m in one year. However, its balance sheet shows it holds HK$74.1m in cash, so it actually has HK$49.0m net cash.

A Look At Fameglow Holdings's Liabilities

We can see from the most recent balance sheet that Fameglow Holdings had liabilities of HK$148.2m falling due within a year, and liabilities of HK$49.5m due beyond that. Offsetting this, it had HK$74.1m in cash and HK$5.93m in receivables that were due within 12 months. So its liabilities total HK$117.8m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Fameglow Holdings is worth HK$208.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Fameglow Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fameglow 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 Fameglow Holdings had a loss before interest and tax, and actually shrunk its revenue by 35%, to HK$72m. To be frank that doesn't bode well.

So How Risky Is Fameglow Holdings?

Although Fameglow Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of HK$3.7m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Fameglow Holdings (1 makes us a bit uncomfortable) you should be aware of.

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. 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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