Here's Why Dynamic Holdings (HKG:29) Can Manage Its Debt Responsibly

Warren Buffett famously said, '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. As with many other companies Dynamic Holdings Limited (HKG:29) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Dynamic Holdings

What Is Dynamic Holdings's Debt?

As you can see below, Dynamic Holdings had HK$99.5m of debt at June 2020, down from HK$107.8m a year prior. However, its balance sheet shows it holds HK$134.3m in cash, so it actually has HK$34.8m net cash.

How Strong Is Dynamic Holdings's Balance Sheet?

We can see from the most recent balance sheet that Dynamic Holdings had liabilities of HK$139.8m falling due within a year, and liabilities of HK$358.1m due beyond that. Offsetting this, it had HK$134.3m in cash and HK$25.2m in receivables that were due within 12 months. So it has liabilities totalling HK$338.4m more than its cash and near-term receivables, combined.

Since publicly traded Dynamic Holdings shares are worth a total of HK$3.47b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Dynamic Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Dynamic Holdings's saving grace is its low debt levels, because its EBIT has tanked 34% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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, a company can only pay off debt with cold hard cash, not accounting profits. While Dynamic Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Dynamic Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Dynamic Holdings has HK$34.8m in net cash. The cherry on top was that in converted 132% of that EBIT to free cash flow, bringing in HK$30m. So we are not troubled with Dynamic Holdings's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Dynamic Holdings (of which 1 doesn't sit too well with us!) 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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