Is Auto Italia Holdings (HKG:720) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Auto Italia Holdings Limited (HKG:720) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. 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.

Check out our latest analysis for Auto Italia Holdings

How Much Debt Does Auto Italia Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Auto Italia Holdings had HK$72.8m of debt, an increase on HK$5.32m, over one year. However, because it has a cash reserve of HK$52.5m, its net debt is less, at about HK$20.3m.

How Healthy Is Auto Italia Holdings' Balance Sheet?

We can see from the most recent balance sheet that Auto Italia Holdings had liabilities of HK$130.6m falling due within a year, and liabilities of HK$1.05m due beyond that. Offsetting these obligations, it had cash of HK$52.5m as well as receivables valued at HK$27.0m due within 12 months. So it has liabilities totalling HK$52.1m more than its cash and near-term receivables, combined.

Of course, Auto Italia Holdings has a market capitalization of HK$1.04b, 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. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Auto Italia 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, Auto Italia Holdings made a loss at the EBIT level, and saw its revenue drop to HK$126m, which is a fall of 46%. That makes us nervous, to say the least.

Caveat Emptor

While Auto Italia Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost HK$59m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of HK$89m. So to be blunt we do think it is risky. 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. For example, we've discovered 1 warning sign for Auto Italia Holdings that you should be aware of before investing here.

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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