Is Silkwave (HKG:471) A Risky Investment?

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 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. Importantly, Silkwave Inc (HKG:471) does carry debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

See our latest analysis for Silkwave

What Is Silkwave's Net Debt?

As you can see below, at the end of June 2024, Silkwave had US$9.22m of debt, up from US$8.47m a year ago. Click the image for more detail. However, because it has a cash reserve of US$722.0k, its net debt is less, at about US$8.49m.

A Look At Silkwave's Liabilities

We can see from the most recent balance sheet that Silkwave had liabilities of US$3.07m falling due within a year, and liabilities of US$9.22m due beyond that. Offsetting this, it had US$722.0k in cash and US$8.82m in receivables that were due within 12 months. So its liabilities total US$2.75m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Silkwave has a market capitalization of US$6.90m, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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 Silkwave'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.

Over 12 months, Silkwave made a loss at the EBIT level, and saw its revenue drop to US$6.9m, which is a fall of 23%. To be frank that doesn't bode well.

Caveat Emptor

While Silkwave's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable US$3.4m 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$2.6m of cash over the last year. So suffice it to say we consider the stock very 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. Be aware that Silkwave is showing 5 warning signs in our investment analysis , and 3 of those are significant...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.