Health Check: How Prudently Does Emperor Culture Group (HKG:491) Use 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 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. Importantly, Emperor Culture Group Limited (HKG:491) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Emperor Culture Group

How Much Debt Does Emperor Culture Group Carry?

As you can see below, at the end of June 2021, Emperor Culture Group had HK$333.0m of debt, up from HK$191.9m a year ago. Click the image for more detail. However, because it has a cash reserve of HK$62.3m, its net debt is less, at about HK$270.6m.

How Healthy Is Emperor Culture Group's Balance Sheet?

According to the last reported balance sheet, Emperor Culture Group had liabilities of HK$199.1m due within 12 months, and liabilities of HK$1.47b due beyond 12 months. On the other hand, it had cash of HK$62.3m and HK$8.07m worth of receivables due within a year. So its liabilities total HK$1.60b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$160.7m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Emperor Culture Group would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Emperor Culture Group will need earnings to service that debt. 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, Emperor Culture Group reported revenue of HK$193m, which is a gain of 53%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though Emperor Culture Group managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping HK$179m. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the fact is that it incinerated HK$75m of cash in the last twelve months, and has precious few liquid assets in comparison to its liabilities. So is this a high risk stock? We think so, and we'd avoid it. 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. To that end, you should learn about the 4 warning signs we've spotted with Emperor Culture Group (including 2 which don'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.