Health Check: How Prudently Does Tongfang Kontafarma Holdings (HKG:1312) Use Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Tongfang Kontafarma Holdings Limited (HKG:1312) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Tongfang Kontafarma Holdings

What Is Tongfang Kontafarma Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Tongfang Kontafarma Holdings had HK$200.5m of debt in June 2022, down from HK$293.4m, one year before. However, it also had HK$153.2m in cash, and so its net debt is HK$47.3m.

How Strong Is Tongfang Kontafarma Holdings' Balance Sheet?

According to the last reported balance sheet, Tongfang Kontafarma Holdings had liabilities of HK$743.2m due within 12 months, and liabilities of HK$436.4m due beyond 12 months. Offsetting this, it had HK$153.2m in cash and HK$391.2m in receivables that were due within 12 months. So its liabilities total HK$635.2m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$206.8m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Tongfang Kontafarma Holdings would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tongfang Kontafarma 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.

In the last year Tongfang Kontafarma Holdings's revenue was pretty flat, and it made a negative EBIT. While that hardly impresses, its not too bad either.

Caveat Emptor

Importantly, Tongfang Kontafarma Holdings had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$50m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it vaporized HK$16m in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is risky, like walking through a dirty dog park with a mask on. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Tongfang Kontafarma Holdings that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.