Brainhole Technology (HKG:2203) Is Making Moderate Use Of Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Brainhole Technology Limited (HKG:2203) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Brainhole Technology

What Is Brainhole Technology's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Brainhole Technology had debt of HK$100.3m, up from HK$35.7m in one year. However, it does have HK$81.0m in cash offsetting this, leading to net debt of about HK$19.2m.

How Strong Is Brainhole Technology's Balance Sheet?

We can see from the most recent balance sheet that Brainhole Technology had liabilities of HK$121.9m falling due within a year, and liabilities of HK$79.9m due beyond that. Offsetting this, it had HK$81.0m in cash and HK$117.9m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Brainhole Technology's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the HK$173.6m company is short on cash, but still worth keeping an eye on the balance sheet. 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 Brainhole Technology 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.

In the last year Brainhole Technology wasn't profitable at an EBIT level, but managed to grow its revenue by 9.1%, to HK$306m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Brainhole Technology had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$28m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled HK$15m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very 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 instance, we've identified 3 warning signs for Brainhole Technology (2 are concerning) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.

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