Here's Why Deson Development International Holdings (HKG:262) Is Weighed Down By Its Debt Load

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Deson Development International Holdings Limited (HKG:262) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Deson Development International Holdings

How Much Debt Does Deson Development International Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that Deson Development International Holdings had HK$460.7m of debt in March 2022, down from HK$485.5m, one year before. However, it also had HK$43.9m in cash, and so its net debt is HK$416.9m.

A Look At Deson Development International Holdings' Liabilities

According to the last reported balance sheet, Deson Development International Holdings had liabilities of HK$419.0m due within 12 months, and liabilities of HK$378.8m due beyond 12 months. Offsetting this, it had HK$43.9m in cash and HK$45.1m in receivables that were due within 12 months. So it has liabilities totalling HK$708.8m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the HK$112.9m 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'd watch its balance sheet closely, without a doubt. At the end of the day, Deson Development International Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Deson Development International Holdings has a debt to EBITDA ratio of 3.1 and its EBIT covered its interest expense 5.3 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. We also note that Deson Development International Holdings improved its EBIT from a last year's loss to a positive HK$125m. When analysing debt levels, the balance sheet is the obvious place to start. But it is Deson Development International 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Considering the last year, Deson Development International Holdings actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

We'd go so far as to say Deson Development International Holdings's level of total liabilities was disappointing. Having said that, its ability to cover its interest expense with its EBIT isn't such a worry. Overall, it seems to us that Deson Development International Holdings's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 3 warning signs for Deson Development International Holdings (1 makes us a bit uncomfortable) you should be aware of.

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.