Is Kontafarma China Holdings (HKG:1312) Using Debt Sensibly?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Kontafarma China Holdings Limited (HKG:1312) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kontafarma China Holdings

What Is Kontafarma China Holdings's Debt?

The image below, which you can click on for greater detail, shows that Kontafarma China Holdings had debt of HK$85.3m at the end of June 2023, a reduction from HK$200.5m over a year. However, its balance sheet shows it holds HK$170.6m in cash, so it actually has HK$85.4m net cash.

A Look At Kontafarma China Holdings' Liabilities

We can see from the most recent balance sheet that Kontafarma China Holdings had liabilities of HK$378.5m falling due within a year, and liabilities of HK$308.3m due beyond that. Offsetting these obligations, it had cash of HK$170.6m as well as receivables valued at HK$407.9m due within 12 months. So its liabilities total HK$108.3m more than the combination of its cash and short-term receivables.

Kontafarma China Holdings has a market capitalization of HK$218.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Kontafarma China Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Kontafarma China Holdings 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.

Over 12 months, Kontafarma China Holdings made a loss at the EBIT level, and saw its revenue drop to HK$874m, which is a fall of 15%. We would much prefer see growth.

So How Risky Is Kontafarma China Holdings?

While Kontafarma China Holdings lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of HK$5.4m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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 Kontafarma China Holdings is showing 4 warning signs in our investment analysis , and 1 of those is concerning...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.