Is Keen Ocean International Holding (HKG:8070) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Keen Ocean International Holding Limited (HKG:8070) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Keen Ocean International Holding

How Much Debt Does Keen Ocean International Holding Carry?

As you can see below, at the end of December 2020, Keen Ocean International Holding had HK$28.3m of debt, up from HK$23.9m a year ago. Click the image for more detail. However, because it has a cash reserve of HK$6.96m, its net debt is less, at about HK$21.3m.

How Healthy Is Keen Ocean International Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Keen Ocean International Holding had liabilities of HK$72.9m due within 12 months and no liabilities due beyond that. On the other hand, it had cash of HK$6.96m and HK$37.5m worth of receivables due within a year. So its liabilities total HK$28.4m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of HK$38.2m, so it does suggest shareholders should keep an eye on Keen Ocean International Holding's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.63 times and a disturbingly high net debt to EBITDA ratio of 6.4 hit our confidence in Keen Ocean International Holding like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Keen Ocean International Holding is that it turned last year's EBIT loss into a gain of HK$891k, over the last twelve months. 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 Keen Ocean International Holding 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Keen Ocean International Holding actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Neither Keen Ocean International Holding's ability to cover its interest expense with its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Taking the abovementioned factors together we do think Keen Ocean International Holding's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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 3 warning signs for Keen Ocean International Holding (2 are a bit concerning!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. 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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