We Think Starlite Holdings (HKG:403) Is Taking Some Risk With Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Starlite Holdings Limited (HKG:403) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Starlite Holdings

What Is Starlite Holdings's Net Debt?

As you can see below, Starlite Holdings had HK$86.2m of debt at September 2020, down from HK$160.6m a year prior. But on the other hand it also has HK$329.6m in cash, leading to a HK$243.4m net cash position.

How Healthy Is Starlite Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Starlite Holdings had liabilities of HK$712.8m due within 12 months and liabilities of HK$8.31m due beyond that. Offsetting this, it had HK$329.6m in cash and HK$293.2m in receivables that were due within 12 months. So it has liabilities totalling HK$98.2m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of HK$141.8m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Starlite Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Starlite Holdings's EBIT was down 47% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is Starlite Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Starlite Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Starlite Holdings actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While Starlite Holdings does have more liabilities than liquid assets, it also has net cash of HK$243.4m. The cherry on top was that in converted 163% of that EBIT to free cash flow, bringing in HK$13m. So while Starlite Holdings does not have a great balance sheet, it's certainly not too bad. 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. Be aware that Starlite Holdings is showing 5 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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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