Dynamic Holdings (HKG:29) Has A Pretty Healthy Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Dynamic Holdings Limited (HKG:29) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Dynamic Holdings

What Is Dynamic Holdings's Net Debt?

As you can see below, Dynamic Holdings had HK$97.6m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has HK$198.8m in cash to offset that, meaning it has HK$101.3m net cash.

How Healthy Is Dynamic Holdings' Balance Sheet?

The latest balance sheet data shows that Dynamic Holdings had liabilities of HK$148.0m due within a year, and liabilities of HK$349.5m falling due after that. Offsetting this, it had HK$198.8m in cash and HK$12.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$286.6m.

Given Dynamic Holdings has a market capitalization of HK$3.38b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Dynamic Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Dynamic Holdings's load is not too heavy, because its EBIT was down 72% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is Dynamic 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 company can only pay off debt with cold hard cash, not accounting profits. 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. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

We could understand if investors are concerned about Dynamic Holdings's liabilities, but we can be reassured by the fact it has has net cash of HK$101.3m. And it impressed us with free cash flow of HK$40m, being 204% of its EBIT. So we don't have any problem with Dynamic Holdings's use of debt. 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 instance, we've identified 2 warning signs for Dynamic Holdings (1 is a bit unpleasant) you should be aware of.

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. 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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