Is New Silkroad Culturaltainment (HKG:472) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 New Silkroad Culturaltainment Limited (HKG:472) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for New Silkroad Culturaltainment

How Much Debt Does New Silkroad Culturaltainment Carry?

As you can see below, at the end of December 2020, New Silkroad Culturaltainment had HK$1.88b of debt, up from HK$1.38b a year ago. Click the image for more detail. However, it does have HK$213.4m in cash offsetting this, leading to net debt of about HK$1.67b.

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$2.13b due within 12 months and liabilities of HK$169.5m due beyond that. Offsetting this, it had HK$213.4m in cash and HK$8.41m in receivables that were due within 12 months. So its liabilities total HK$2.08b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$513.2m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, New Silkroad Culturaltainment would probably need a major re-capitalization if its creditors were to demand repayment. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year New Silkroad Culturaltainment had a loss before interest and tax, and actually shrunk its revenue by 44%, to HK$118m. That makes us nervous, to say the least.

Caveat Emptor

Not only did New Silkroad Culturaltainment's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping HK$63m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost HK$92m in just last twelve months, and it doesn't have much by way of liquid assets. So while it's not wise to assume the company will fail, we do think it's risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with New Silkroad Culturaltainment (at least 1 which is significant) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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