Is Forward Fashion (International) Holdings (HKG:2528) Weighed On By Its Debt Load?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that Forward Fashion (International) Holdings Company Limited (HKG:2528) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Forward Fashion (International) Holdings

How Much Debt Does Forward Fashion (International) Holdings Carry?

As you can see below, Forward Fashion (International) Holdings had HK$294.9m of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. However, it also had HK$258.4m in cash, and so its net debt is HK$36.5m.

How Healthy Is Forward Fashion (International) Holdings' Balance Sheet?

According to the last reported balance sheet, Forward Fashion (International) Holdings had liabilities of HK$584.5m due within 12 months, and liabilities of HK$260.4m due beyond 12 months. On the other hand, it had cash of HK$258.4m and HK$45.9m worth of receivables due within a year. So its liabilities total HK$540.5m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of HK$528.0m, we think shareholders really should watch Forward Fashion (International) Holdings's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Forward Fashion (International) 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.

Over 12 months, Forward Fashion (International) Holdings reported revenue of HK$1.1b, which is a gain of 2.7%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Forward Fashion (International) Holdings had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at HK$42m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of HK$18m. In the meantime, we consider the stock to be risky. 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. To that end, you should learn about the 3 warning signs we've spotted with Forward Fashion (International) Holdings (including 1 which can't be ignored) .

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.

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.

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