Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Daisho Microline Holdings Limited (HKG:567) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Daisho Microline Holdings's Net Debt?
As you can see below, at the end of March 2021, Daisho Microline Holdings had HK$85.6m of debt, up from HK$78.4m a year ago. Click the image for more detail. However, it also had HK$30.3m in cash, and so its net debt is HK$55.2m.
A Look At Daisho Microline Holdings' Liabilities
Zooming in on the latest balance sheet data, we can see that Daisho Microline Holdings had liabilities of HK$126.0m due within 12 months and liabilities of HK$9.05m due beyond that. On the other hand, it had cash of HK$30.3m and HK$58.4m worth of receivables due within a year. So its liabilities total HK$46.3m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Daisho Microline Holdings is worth HK$127.4m, and thus could probably raise enough capital to shore up 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 Daisho Microline 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.
In the last year Daisho Microline Holdings had a loss before interest and tax, and actually shrunk its revenue by 94%, to HK$68m. To be frank that doesn't bode well.
Not only did Daisho Microline Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping HK$27m. 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$37m. So we do think this stock is quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Daisho Microline Holdings that you should be aware of before investing here.
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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