DTXS Silk Road Investment Holdings (HKG:620) Takes On Some Risk With Its Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies DTXS Silk Road Investment Holdings Company Limited (HKG:620) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for DTXS Silk Road Investment Holdings

What Is DTXS Silk Road Investment Holdings's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 DTXS Silk Road Investment Holdings had debt of HK$711.8m, up from none in one year. However, it also had HK$198.1m in cash, and so its net debt is HK$513.6m.

How Strong Is DTXS Silk Road Investment Holdings' Balance Sheet?

We can see from the most recent balance sheet that DTXS Silk Road Investment Holdings had liabilities of HK$1.20b falling due within a year, and liabilities of HK$20.3m due beyond that. Offsetting these obligations, it had cash of HK$198.1m as well as receivables valued at HK$595.4m due within 12 months. So its liabilities total HK$429.4m more than the combination of its cash and short-term receivables.

Of course, DTXS Silk Road Investment Holdings has a market capitalization of HK$4.06b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Strangely DTXS Silk Road Investment Holdings has a sky high EBITDA ratio of 30.5, implying high debt, but a strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. We also note that DTXS Silk Road Investment Holdings improved its EBIT from a last year's loss to a positive HK$4.4m. There's no doubt that we learn most about debt from the balance sheet. But it is DTXS Silk Road Investment 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. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Considering the last year, DTXS Silk Road Investment Holdings actually recorded a cash outflow, overall. 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

Neither DTXS Silk Road Investment Holdings's ability handle its debt, based on its EBITDA, nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. We think that DTXS Silk Road Investment Holdings's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for DTXS Silk Road Investment Holdings (of which 1 doesn't sit too well with us!) you should know about.

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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