Dalipal Holdings (HKG:1921) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Dalipal Holdings Limited (HKG:1921) does carry debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Dalipal Holdings

How Much Debt Does Dalipal Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Dalipal Holdings had CN¥2.04b of debt, an increase on CN¥1.90b, over one year. However, it also had CN¥425.0m in cash, and so its net debt is CN¥1.62b.

How Healthy Is Dalipal Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dalipal Holdings had liabilities of CN¥2.65b due within 12 months and liabilities of CN¥411.6m due beyond that. On the other hand, it had cash of CN¥425.0m and CN¥1.28b worth of receivables due within a year. So it has liabilities totalling CN¥1.36b more than its cash and near-term receivables, combined.

Given Dalipal Holdings has a market capitalization of CN¥10.2b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Dalipal Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (7.7), and fairly weak interest coverage, since EBIT is just 1.1 times the interest expense. The debt burden here is substantial. Even worse, Dalipal Holdings saw its EBIT tank 71% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 Dalipal 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Dalipal Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Neither Dalipal Holdings's ability to grow its EBIT nor its interest cover gave us confidence in its ability to take on more debt. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Dalipal Holdings's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. To that end, you should learn about the 4 warning signs we've spotted with Dalipal Holdings (including 2 which can't be ignored) .

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.