Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Enterprise Development Holdings Limited (HKG:1808) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Enterprise Development Holdings's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Enterprise Development Holdings had CN¥9.77m of debt in June 2021, down from CN¥14.6m, one year before. However, its balance sheet shows it holds CN¥129.8m in cash, so it actually has CN¥120.0m net cash.
How Strong Is Enterprise Development Holdings' Balance Sheet?
According to the balance sheet data, Enterprise Development Holdings had liabilities of CN¥26.5m due within 12 months, but no longer term liabilities. Offsetting these obligations, it had cash of CN¥129.8m as well as receivables valued at CN¥43.0m due within 12 months. So it actually has CN¥146.2m more liquid assets than total liabilities.
This luscious liquidity implies that Enterprise Development Holdings' balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Enterprise Development Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is Enterprise Development 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.
In the last year Enterprise Development Holdings had a loss before interest and tax, and actually shrunk its revenue by 33%, to CN¥61m. That makes us nervous, to say the least.
So How Risky Is Enterprise Development Holdings?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Enterprise Development Holdings had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of CN¥23m and booked a CN¥20m accounting loss. But the saving grace is the CN¥120.0m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Enterprise Development Holdings is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...
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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