Does Auto Italia Holdings (HKG:720) Have A Healthy Balance Sheet?

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.' 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. Importantly, Auto Italia Holdings Limited (HKG:720) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Auto Italia Holdings

What Is Auto Italia Holdings's Debt?

As you can see below, at the end of June 2024, Auto Italia Holdings had HK$402.2m of debt, up from HK$383.7m a year ago. Click the image for more detail. On the flip side, it has HK$36.4m in cash leading to net debt of about HK$365.7m.

How Healthy Is Auto Italia Holdings' Balance Sheet?

The latest balance sheet data shows that Auto Italia Holdings had liabilities of HK$390.7m due within a year, and liabilities of HK$32.4m falling due after that. On the other hand, it had cash of HK$36.4m and HK$8.14m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$378.5m.

This deficit isn't so bad because Auto Italia Holdings is worth HK$857.4m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Auto Italia Holdings'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.

Over 12 months, Auto Italia Holdings made a loss at the EBIT level, and saw its revenue drop to HK$37m, which is a fall of 4.8%. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Auto Italia Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost HK$6.6m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through HK$4.4m of cash over the last year. So suffice it to say we do consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Auto Italia Holdings (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.