Is Century Entertainment International Holdings (HKG:959) Weighed On By Its Debt Load?

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 can see that Century Entertainment International Holdings Limited (HKG:959) does use debt in its business. 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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Century Entertainment International Holdings

How Much Debt Does Century Entertainment International Holdings Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Century Entertainment International Holdings had debt of HK$127.9m, up from HK$98.1m in one year. However, it also had HK$3.65m in cash, and so its net debt is HK$124.2m.

How Healthy Is Century Entertainment International Holdings' Balance Sheet?

We can see from the most recent balance sheet that Century Entertainment International Holdings had liabilities of HK$137.8m falling due within a year, and liabilities of HK$5.00m due beyond that. Offsetting these obligations, it had cash of HK$3.65m as well as receivables valued at HK$48.7m due within 12 months. So its liabilities total HK$90.4m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's HK$64.1m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. 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 Entertainment International 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.

Over 12 months, Century Entertainment International Holdings reported revenue of HK$27m, which is a gain of 33%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Century Entertainment International Holdings still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable HK$37m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through HK$531k in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. To that end, you should learn about the 2 warning signs we've spotted with Century Entertainment International Holdings (including 1 which is concerning) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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