Is Kidsland International Holdings (HKG:2122) Using Debt In A Risky Way?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Kidsland International Holdings Limited (HKG:2122) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Kidsland International Holdings

What Is Kidsland International Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Kidsland International Holdings had debt of CN¥63.7m, up from CN¥33.0m in one year. However, because it has a cash reserve of CN¥37.0m, its net debt is less, at about CN¥26.7m.

How Healthy Is Kidsland International Holdings' Balance Sheet?

According to the last reported balance sheet, Kidsland International Holdings had liabilities of CN¥355.0m due within 12 months, and liabilities of CN¥65.6m due beyond 12 months. Offsetting this, it had CN¥37.0m in cash and CN¥140.9m in receivables that were due within 12 months. So its liabilities total CN¥242.7m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥71.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Kidsland International Holdings would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Kidsland International 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.

Over 12 months, Kidsland International Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥1.3b, which is a fall of 11%. That's not what we would hope to see.

Caveat Emptor

Not only did Kidsland International Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping CN¥40m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of CN¥73m in the last year. So while it's not wise to assume the company will fail, we do think it's risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Kidsland International Holdings you should be aware of, and 1 of them is concerning.

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.