Dynamic Holdings (HKG:29) Seems To Use Debt Rather Sparingly

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, Dynamic Holdings Limited (HKG:29) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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.

Check out our latest analysis for Dynamic Holdings

What Is Dynamic Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Dynamic Holdings had HK$69.9m of debt in December 2022, down from HK$93.7m, one year before. However, it does have HK$161.6m in cash offsetting this, leading to net cash of HK$91.6m.

A Look At Dynamic Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Dynamic Holdings had liabilities of HK$205.9m due within 12 months and liabilities of HK$261.9m due beyond that. Offsetting these obligations, it had cash of HK$161.6m as well as receivables valued at HK$20.6m due within 12 months. So its liabilities total HK$285.6m more than the combination of its cash and short-term receivables.

Of course, Dynamic Holdings has a market capitalization of HK$2.52b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Dynamic Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Dynamic Holdings grew its EBIT by 93% over the last twelve months, and that growth will make it easier to handle its debt. 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 Dynamic 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Dynamic Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Dynamic Holdings actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While Dynamic Holdings does have more liabilities than liquid assets, it also has net cash of HK$91.6m. The cherry on top was that in converted 319% of that EBIT to free cash flow, bringing in HK$2.1m. So is Dynamic Holdings's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. 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 1 warning sign for Dynamic Holdings you should know about.

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.