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

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. We can see that Starlite Holdings Limited (HKG:403) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Starlite Holdings

What Is Starlite Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Starlite Holdings had debt of HK$86.2m at the end of September 2020, a reduction from HK$160.6m over a year. But on the other hand it also has HK$329.6m in cash, leading to a HK$243.4m net cash position.

How Strong Is Starlite Holdings' 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 these obligations, it had cash of HK$329.6m as well as receivables valued at HK$293.2m due within 12 months. So its liabilities total HK$98.2m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of HK$162.8m. 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!

Importantly, Starlite Holdings's EBIT fell a jaw-dropping 47% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Starlite Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Starlite Holdings actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although Starlite Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$243.4m. And it impressed us with free cash flow of HK$13m, being 163% of its EBIT. So although we see some areas for improvement, we're not too worried about Starlite Holdings's balance sheet. 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. Case in point: We've spotted 3 warning signs for Starlite Holdings you should be aware of, and 1 of them shouldn't be ignored.

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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