Is iDreamSky Technology Holdings (HKG:1119) Using Too Much 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.' 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. Importantly, iDreamSky Technology Holdings Limited (HKG:1119) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for iDreamSky Technology Holdings

What Is iDreamSky Technology Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that iDreamSky Technology Holdings had CN¥1.50b of debt in December 2022, down from CN¥1.75b, one year before. On the flip side, it has CN¥216.4m in cash leading to net debt of about CN¥1.29b.

How Strong Is iDreamSky Technology Holdings' Balance Sheet?

We can see from the most recent balance sheet that iDreamSky Technology Holdings had liabilities of CN¥2.45b falling due within a year, and liabilities of CN¥82.1m due beyond that. Offsetting this, it had CN¥216.4m in cash and CN¥835.5m in receivables that were due within 12 months. So it has liabilities totalling CN¥1.48b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since iDreamSky Technology Holdings has a market capitalization of CN¥3.96b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if iDreamSky Technology Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year iDreamSky Technology Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 3.7%, to CN¥2.7b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, iDreamSky Technology Holdings had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping CN¥1.5b. 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¥128m of cash over the last year. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for iDreamSky Technology Holdings you should know about.

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.

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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.