Is DTXS Silk Road Investment Holdings (HKG:620) Using Too Much Debt?

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. We note that DTXS Silk Road Investment Holdings Company Limited (HKG:620) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for DTXS Silk Road Investment Holdings

How Much Debt Does DTXS Silk Road Investment Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 DTXS Silk Road Investment Holdings had HK$698.4m of debt, an increase on HK$58.6m, over one year. On the flip side, it has HK$56.4m in cash leading to net debt of about HK$642.1m.

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

We can see from the most recent balance sheet that DTXS Silk Road Investment Holdings had liabilities of HK$1.11b falling due within a year, and liabilities of HK$22.8m due beyond that. Offsetting this, it had HK$56.4m in cash and HK$768.7m in receivables that were due within 12 months. So its liabilities total HK$308.3m more than the combination of its cash and short-term receivables.

Of course, DTXS Silk Road Investment Holdings has a market capitalization of HK$2.08b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely DTXS Silk Road Investment Holdings has a sky high EBITDA ratio of 40.9, implying high debt, but a strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! We also note that DTXS Silk Road Investment Holdings improved its EBIT from a last year's loss to a positive HK$5.8m. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, DTXS Silk Road Investment Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither DTXS Silk Road Investment Holdings's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think DTXS Silk Road Investment Holdings's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for DTXS Silk Road Investment Holdings you should be aware of, and 1 of them is significant.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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