Easyknit International Holdings (HKG:1218) Has Debt But No Earnings; Should You Worry?

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 Easyknit International Holdings Limited (HKG:1218) does use debt in its business. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Easyknit International Holdings

What Is Easyknit International Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Easyknit International Holdings had HK$1.57b of debt, an increase on HK$1.40b, over one year. However, because it has a cash reserve of HK$302.8m, its net debt is less, at about HK$1.26b.

A Look At Easyknit International Holdings' Liabilities

We can see from the most recent balance sheet that Easyknit International Holdings had liabilities of HK$1.13b falling due within a year, and liabilities of HK$588.0m due beyond that. Offsetting these obligations, it had cash of HK$302.8m as well as receivables valued at HK$201.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$1.21b.

This deficit casts a shadow over the HK$329.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Easyknit International Holdings would likely require a major re-capitalisation if it had to pay its creditors today. 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 Easyknit International Holdings will need earnings to service that debt. 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 Easyknit International Holdings had a loss before interest and tax, and actually shrunk its revenue by 93%, to HK$55m. To be frank that doesn't bode well.

Caveat Emptor

While Easyknit International Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping HK$36m. 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$45m 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. 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. For example, we've discovered 3 warning signs for Easyknit International Holdings (2 are a bit concerning!) that you should be aware of before investing here.

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. 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.
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