Health Check: How Prudently Does Orange Sky Golden Harvest Entertainment (Holdings) (HKG:1132) Use Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Orange Sky Golden Harvest Entertainment (Holdings) Limited (HKG:1132) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. 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.

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

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

The image below, which you can click on for greater detail, shows that at June 2020 Orange Sky Golden Harvest Entertainment (Holdings) had debt of HK$1.25b, up from HK$1.18b in one year. However, because it has a cash reserve of HK$1.16b, its net debt is less, at about HK$87.4m.

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

According to the last reported balance sheet, Orange Sky Golden Harvest Entertainment (Holdings) had liabilities of HK$1.59b due within 12 months, and liabilities of HK$884.0m due beyond 12 months. On the other hand, it had cash of HK$1.16b and HK$103.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$1.20b.

The deficiency here weighs heavily on the HK$456.3m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Orange Sky Golden Harvest Entertainment (Holdings) would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Orange Sky Golden Harvest Entertainment (Holdings)'s earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Orange Sky Golden Harvest Entertainment (Holdings) had a loss before interest and tax, and actually shrunk its revenue by 38%, to HK$665m. To be frank that doesn't bode well.

Caveat Emptor

While Orange Sky Golden Harvest Entertainment (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. Its EBIT loss was a whopping HK$69m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of HK$195m in the last year. So we think this stock is quite risky. We'd prefer to pass. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Orange Sky Golden Harvest Entertainment (Holdings) (including 1 which makes us a bit uncomfortable) .

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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