Is iDreamSky Technology Holdings (HKG:1119) Using Too Much Debt?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that iDreamSky Technology Holdings Limited (HKG:1119) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

Check out our latest analysis for iDreamSky Technology Holdings

How Much Debt Does iDreamSky Technology Holdings Carry?

As you can see below, iDreamSky Technology Holdings had CN¥1.53b of debt at June 2022, down from CN¥1.99b a year prior. However, because it has a cash reserve of CN¥258.4m, its net debt is less, at about CN¥1.27b.

How Healthy Is iDreamSky Technology Holdings' Balance Sheet?

We can see from the most recent balance sheet that iDreamSky Technology Holdings had liabilities of CN¥1.69b falling due within a year, and liabilities of CN¥522.5m due beyond that. Offsetting this, it had CN¥258.4m in cash and CN¥1.23b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥722.2m.

Given iDreamSky Technology Holdings has a market capitalization of CN¥4.47b, 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. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine iDreamSky Technology Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, iDreamSky Technology Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥2.7b, which is a fall of 11%. We would much prefer see growth.

Caveat Emptor

While iDreamSky Technology Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥112m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥866k of cash over the last year. So suffice it to say we do consider the stock to be risky. 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 1 warning sign for iDreamSky Technology Holdings that you should be aware of before investing here.

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. 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.