Is China Star Entertainment (HKG:326) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies China Star Entertainment Limited (HKG:326) makes use of debt. But should shareholders be worried about its use of debt?

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.

View our latest analysis for China Star Entertainment

What Is China Star Entertainment's Net Debt?

The chart below, which you can click on for greater detail, shows that China Star Entertainment had HK$1.70b in debt in June 2023; about the same as the year before. On the flip side, it has HK$665.2m in cash leading to net debt of about HK$1.03b.

How Healthy Is China Star Entertainment's Balance Sheet?

According to the last reported balance sheet, China Star Entertainment had liabilities of HK$798.3m due within 12 months, and liabilities of HK$1.56b due beyond 12 months. Offsetting this, it had HK$665.2m in cash and HK$496.4m in receivables that were due within 12 months. So its liabilities total HK$1.20b more than the combination of its cash and short-term receivables.

China Star Entertainment has a market capitalization of HK$2.21b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is China Star Entertainment'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.

Over 12 months, China Star Entertainment reported revenue of HK$125m, which is a gain of 3,071%, although it did not report any earnings before interest and tax. That's virtually the hole-in-one of revenue growth!

Caveat Emptor

Despite the top line growth, China Star Entertainment still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost HK$108m at the EBIT level. 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 HK$48m 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. However, not all investment risk resides within the balance sheet - far from it. For example - China Star Entertainment has 1 warning sign we think you should be aware of.

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.