Is Road King Infrastructure (HKG:1098) Using Debt Sensibly?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Road King Infrastructure Limited (HKG:1098) does carry debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for Road King Infrastructure

What Is Road King Infrastructure's Net Debt?

As you can see below, Road King Infrastructure had HK$20.0b of debt at June 2024, down from HK$26.0b a year prior. However, it also had HK$6.72b in cash, and so its net debt is HK$13.3b.

How Healthy Is Road King Infrastructure's Balance Sheet?

The latest balance sheet data shows that Road King Infrastructure had liabilities of HK$27.6b due within a year, and liabilities of HK$12.5b falling due after that. Offsetting these obligations, it had cash of HK$6.72b as well as receivables valued at HK$4.07b due within 12 months. So its liabilities total HK$29.4b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$1.39b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Road King Infrastructure would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Road King Infrastructure's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Road King Infrastructure had a loss before interest and tax, and actually shrunk its revenue by 44%, to HK$10b. To be frank that doesn't bode well.

Caveat Emptor

Not only did Road King Infrastructure's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping HK$2.7b. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it lost HK$3.8b in the last year. So we think buying this stock is risky. 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. Be aware that Road King Infrastructure is showing 3 warning signs in our investment analysis , and 2 of those are 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.