Is China Star Entertainment (HKG:326) Weighed On By Its Debt Load?

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.' 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 note that China Star Entertainment Limited (HKG:326) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China Star Entertainment

What Is China Star Entertainment's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 China Star Entertainment had HK$1.15b of debt, an increase on HK$758.0m, over one year. However, it does have HK$1.23b in cash offsetting this, leading to net cash of HK$80.2m.

A Look At China Star Entertainment's Liabilities

According to the last reported balance sheet, China Star Entertainment had liabilities of HK$1.77b due within 12 months, and liabilities of HK$4.35m due beyond 12 months. On the other hand, it had cash of HK$1.23b and HK$101.4m worth of receivables due within a year. So its liabilities total HK$449.0m more than the combination of its cash and short-term receivables.

Since publicly traded China Star Entertainment shares are worth a total of HK$3.89b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, China Star Entertainment also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since China Star Entertainment 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.

In the last year China Star Entertainment wasn't profitable at an EBIT level, but managed to grow its revenue by 314%, to HK$8.6m. When it comes to revenue growth, that's like nailing the game winning 3-pointer!

So How Risky Is China Star Entertainment?

Although China Star Entertainment had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of HK$82m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. One positive is that China Star Entertainment is growing revenue apace, which makes it easier to sell a growth story and raise capital if need be. But we still think it's somewhat risky. 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. Take risks, for example - China Star Entertainment has 2 warning signs (and 1 which is concerning) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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