Is eSun Holdings (HKG:571) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that eSun Holdings Limited (HKG:571) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for eSun Holdings

What Is eSun Holdings's Debt?

The chart below, which you can click on for greater detail, shows that eSun Holdings had HK$383.0m in debt in July 2021; about the same as the year before. But on the other hand it also has HK$1.62b in cash, leading to a HK$1.24b net cash position.

A Look At eSun Holdings' Liabilities

According to the last reported balance sheet, eSun Holdings had liabilities of HK$1.06b due within 12 months, and liabilities of HK$1.34b due beyond 12 months. Offsetting this, it had HK$1.62b in cash and HK$106.9m in receivables that were due within 12 months. So it has liabilities totalling HK$664.9m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of HK$507.2m, we think shareholders really should watch eSun Holdings's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Given that eSun Holdings has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. The balance sheet is clearly the area to focus on when you are analysing debt. But it is eSun 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.

Over 12 months, eSun Holdings made a loss at the EBIT level, and saw its revenue drop to HK$835m, which is a fall of 10%. We would much prefer see growth.

So How Risky Is eSun Holdings?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months eSun Holdings lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through HK$227m of cash and made a loss of HK$351m. Given it only has net cash of HK$1.24b, the company may need to raise more capital if it doesn't reach break-even soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that eSun Holdings is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

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. 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.