Is S.A.S. Dragon Holdings (HKG:1184) Using Too Much 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.' 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. We note that S.A.S. Dragon Holdings Limited (HKG:1184) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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

Check out our latest analysis for S.A.S. Dragon Holdings

How Much Debt Does S.A.S. Dragon Holdings Carry?

The image below, which you can click on for greater detail, shows that S.A.S. Dragon Holdings had debt of HK$2.52b at the end of June 2023, a reduction from HK$4.07b over a year. But on the other hand it also has HK$4.66b in cash, leading to a HK$2.14b net cash position.

How Healthy Is S.A.S. Dragon Holdings' Balance Sheet?

According to the last reported balance sheet, S.A.S. Dragon Holdings had liabilities of HK$6.73b due within 12 months, and liabilities of HK$237.3m due beyond 12 months. Offsetting this, it had HK$4.66b in cash and HK$1.71b in receivables that were due within 12 months. So it has liabilities totalling HK$594.6m more than its cash and near-term receivables, combined.

This deficit isn't so bad because S.A.S. Dragon Holdings is worth HK$2.08b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, S.A.S. Dragon Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that S.A.S. Dragon Holdings's load is not too heavy, because its EBIT was down 20% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 S.A.S. Dragon Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. S.A.S. Dragon Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, S.A.S. Dragon Holdings produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While S.A.S. Dragon Holdings does have more liabilities than liquid assets, it also has net cash of HK$2.14b. So we don't have any problem with S.A.S. Dragon Holdings's use of debt. 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. Be aware that S.A.S. Dragon Holdings is showing 1 warning sign in our investment analysis , you should know about...

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.

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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.