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

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.' 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. We can see that Kontafarma China Holdings Limited (HKG:1312) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Kontafarma China Holdings

How Much Debt Does Kontafarma China Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that Kontafarma China Holdings had HK$43.3m of debt in June 2024, down from HK$85.3m, one year before. But it also has HK$78.7m in cash to offset that, meaning it has HK$35.4m net cash.

How Healthy Is Kontafarma China Holdings' Balance Sheet?

According to the last reported balance sheet, Kontafarma China Holdings had liabilities of HK$404.6m due within 12 months, and liabilities of HK$226.5m due beyond 12 months. Offsetting these obligations, it had cash of HK$78.7m as well as receivables valued at HK$418.7m due within 12 months. So it has liabilities totalling HK$133.8m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of HK$150.9m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Kontafarma China Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. 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$837m, which is a fall of 4.2%. That's not what we would hope to see.

So How Risky Is Kontafarma China Holdings?

While Kontafarma China Holdings lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow HK$62m. 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Kontafarma China Holdings (of which 1 makes us a bit uncomfortable!) you should know about.

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.