Is Kontafarma China Holdings (HKG:1312) Weighed On By Its Debt Load?

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.' 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. Importantly, Kontafarma China Holdings Limited (HKG:1312) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Kontafarma China Holdings

What Is Kontafarma China Holdings's Debt?

As you can see below, Kontafarma China Holdings had HK$43.3m of debt at June 2024, down from HK$85.3m a year prior. But it also has HK$78.7m in cash to offset that, meaning it has HK$35.4m net cash.

How Strong Is Kontafarma China Holdings' Balance Sheet?

The latest balance sheet data shows that Kontafarma China Holdings had liabilities of HK$404.6m due within a year, and liabilities of HK$226.5m falling due after that. Offsetting this, it had HK$78.7m in cash and HK$418.7m in receivables that were due within 12 months. So its liabilities total HK$133.8m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of HK$156.5m, so it does suggest shareholders should keep an eye on Kontafarma China Holdings' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Kontafarma China Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. 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.

In the last year Kontafarma China Holdings had a loss before interest and tax, and actually shrunk its revenue by 4.2%, to HK$837m. That's not what we would hope to see.

So How Risky Is Kontafarma China Holdings?

Although Kontafarma China Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of HK$13m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. 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. To that end, you should learn about the 2 warning signs we've spotted with Kontafarma China Holdings (including 1 which is potentially serious) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.