We Think King Fook Holdings (HKG:280) Can Manage Its Debt With Ease

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, King Fook Holdings Limited (HKG:280) does carry debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for King Fook Holdings

What Is King Fook Holdings's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 King Fook Holdings had debt of HK$32.3m, up from HK$29.4m in one year. However, its balance sheet shows it holds HK$254.8m in cash, so it actually has HK$222.5m net cash.

A Look At King Fook Holdings's Liabilities

The latest balance sheet data shows that King Fook Holdings had liabilities of HK$110.4m due within a year, and liabilities of HK$50.5m falling due after that. On the other hand, it had cash of HK$254.8m and HK$17.2m worth of receivables due within a year. So it can boast HK$111.1m 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). On this view, lenders should feel as safe as the beloved of a black-belt karate master. 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.

Better yet, King Fook Holdings grew its EBIT by 157% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is King Fook Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Over the last two years, King Fook Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case King Fook Holdings has HK$222.5m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$91m, being 475% of its EBIT. The bottom line is that we do not find King Fook Holdings's debt levels at all concerning. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for King Fook Holdings you should know about.

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.

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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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