Is Brainhole Technology (HKG:2203) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Brainhole Technology Limited (HKG:2203) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at 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 December 2022 Brainhole Technology had debt of HK$144.6m, up from HK$80.1m in one year. However, it does have HK$98.7m in cash offsetting this, leading to net debt of about HK$45.9m.

A Look At Brainhole Technology's Liabilities

The latest balance sheet data shows that Brainhole Technology had liabilities of HK$150.4m due within a year, and liabilities of HK$81.5m falling due after that. On the other hand, it had cash of HK$98.7m and HK$94.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$38.5m.

Brainhole Technology has a market capitalization of HK$108.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. 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 had a loss before interest and tax, and actually shrunk its revenue by 18%, to HK$264m. That's not what we would hope to see.

Caveat Emptor

While Brainhole Technology'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 a very considerable HK$23m at the EBIT level. 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. We would feel better if it turned its trailing twelve month loss of HK$58m into a profit. So we do think this stock is quite 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. Case in point: We've spotted 3 warning signs for Brainhole Technology you should be aware of, and 2 of them make us uncomfortable.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.