Does Orange Sky Golden Harvest Entertainment (Holdings) (HKG:1132) Have A Healthy Balance Sheet?

Warren Buffett famously said, '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. We note that Orange Sky Golden Harvest Entertainment (Holdings) Limited (HKG:1132) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Orange Sky Golden Harvest Entertainment (Holdings)

What Is Orange Sky Golden Harvest Entertainment (Holdings)'s Debt?

As you can see below, Orange Sky Golden Harvest Entertainment (Holdings) had HK$764.9m of debt at June 2022, down from HK$1.12b a year prior. However, it does have HK$574.5m in cash offsetting this, leading to net debt of about HK$190.5m.

How Strong Is Orange Sky Golden Harvest Entertainment (Holdings)'s Balance Sheet?

We can see from the most recent balance sheet that Orange Sky Golden Harvest Entertainment (Holdings) had liabilities of HK$1.18b falling due within a year, and liabilities of HK$1.25b due beyond that. Offsetting these obligations, it had cash of HK$574.5m as well as receivables valued at HK$89.0m due within 12 months. So it has liabilities totalling HK$1.76b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$175.1m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Orange Sky Golden Harvest Entertainment (Holdings) would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Orange Sky Golden Harvest Entertainment (Holdings) has a quite reasonable net debt to EBITDA multiple of 2.2, its interest cover seems weak, at 0.99. In large part that's it has so much depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) Either way there's no doubt the stock is using meaningful leverage. We also note that Orange Sky Golden Harvest Entertainment (Holdings) improved its EBIT from a last year's loss to a positive HK$35m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Orange Sky Golden Harvest Entertainment (Holdings) 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Orange Sky Golden Harvest Entertainment (Holdings) saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Orange Sky Golden Harvest Entertainment (Holdings)'s conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. After considering the datapoints discussed, we think Orange Sky Golden Harvest Entertainment (Holdings) has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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 2 warning signs for Orange Sky Golden Harvest Entertainment (Holdings) you should be aware of, and 1 of them doesn't sit too well with us.

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.