Is Celestial Asia Securities Holdings (HKG:1049) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Celestial Asia Securities Holdings Limited (HKG:1049) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Celestial Asia Securities Holdings

What Is Celestial Asia Securities Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Celestial Asia Securities Holdings had HK$162.3m of debt in December 2020, down from HK$254.9m, one year before. However, because it has a cash reserve of HK$152.7m, its net debt is less, at about HK$9.61m.

How Healthy Is Celestial Asia Securities Holdings' Balance Sheet?

We can see from the most recent balance sheet that Celestial Asia Securities Holdings had liabilities of HK$687.3m falling due within a year, and liabilities of HK$156.8m due beyond that. Offsetting these obligations, it had cash of HK$152.7m as well as receivables valued at HK$139.1m due within 12 months. So it has liabilities totalling HK$552.2m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$129.2m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Celestial Asia Securities Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Given net debt is only 0.12 times EBITDA, it is initially surprising to see that Celestial Asia Securities Holdings's EBIT has low interest coverage of 2.5 times. So while we're not necessarily alarmed we think that its debt is far from trivial. We also note that Celestial Asia Securities Holdings improved its EBIT from a last year's loss to a positive HK$57m. 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 Celestial Asia Securities 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Celestial Asia Securities Holdings recorded negative free cash flow, in total. 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 Celestial Asia Securities Holdings's level of total liabilities was disappointing. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Overall, it seems to us that Celestial Asia Securities Holdings's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Be aware that Celestial Asia Securities Holdings is showing 4 warning signs in our investment analysis , and 2 of those make us uncomfortable...

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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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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