King Fook Holdings (HKG:280) Could Easily Take On More Debt

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that King Fook Holdings Limited (HKG:280) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for King Fook Holdings

What Is King Fook Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 King Fook Holdings had HK$37.8m of debt, an increase on HK$32.3m, over one year. But on the other hand it also has HK$363.9m in cash, leading to a HK$326.1m net cash position.

A Look At King Fook Holdings' Liabilities

The latest balance sheet data shows that King Fook Holdings had liabilities of HK$138.7m due within a year, and liabilities of HK$45.2m falling due after that. Offsetting these obligations, it had cash of HK$363.9m as well as receivables valued at HK$13.9m due within 12 months. So it can boast HK$193.8m more liquid assets than total liabilities.

This surplus strongly suggests that King Fook Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that King Fook Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that King Fook Holdings grew its EBIT by 148% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is King Fook Holdings's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While King Fook 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. Happily for any shareholders, King Fook Holdings actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that King Fook Holdings has net cash of HK$326.1m, as well as more liquid assets than liabilities. The cherry on top was that in converted 405% of that EBIT to free cash flow, bringing in HK$162m. The bottom line is that King Fook Holdings's use of debt is absolutely fine. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for King Fook Holdings you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.