Is New Silkroad Culturaltainment (HKG:472) 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.' 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. As with many other companies New Silkroad Culturaltainment Limited (HKG:472) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for New Silkroad Culturaltainment

What Is New Silkroad Culturaltainment's Debt?

You can click the graphic below for the historical numbers, but it shows that New Silkroad Culturaltainment had HK$14.3m of debt in December 2022, down from HK$173.8m, one year before. However, it does have HK$554.7m in cash offsetting this, leading to net cash of HK$540.4m.

How Healthy Is New Silkroad Culturaltainment's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that New Silkroad Culturaltainment had liabilities of HK$257.8m due within 12 months and liabilities of HK$76.7m due beyond that. Offsetting this, it had HK$554.7m in cash and HK$13.5m in receivables that were due within 12 months. So it actually has HK$233.7m more liquid assets than total liabilities.

This surplus strongly suggests that New Silkroad Culturaltainment has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that New Silkroad Culturaltainment has more cash than debt is arguably a good indication that it can manage its debt safely. 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 New Silkroad Culturaltainment 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 New Silkroad Culturaltainment had a loss before interest and tax, and actually shrunk its revenue by 86%, to HK$369m. To be frank that doesn't bode well.

So How Risky Is New Silkroad Culturaltainment?

Although New Silkroad Culturaltainment had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of HK$107m. 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. The next few years will be important as the business matures. 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 example, we've discovered 2 warning signs for New Silkroad Culturaltainment (1 doesn't sit too well with us!) that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.