Health Check: How Prudently Does Kwoon Chung Bus Holdings (HKG:306) Use 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 can see that Kwoon Chung Bus Holdings Limited (HKG:306) does use debt in its business. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Kwoon Chung Bus Holdings

How Much Debt Does Kwoon Chung Bus Holdings Carry?

As you can see below, Kwoon Chung Bus Holdings had HK$1.94b of debt, at September 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has HK$557.7m in cash leading to net debt of about HK$1.38b.

How Healthy Is Kwoon Chung Bus Holdings' Balance Sheet?

According to the last reported balance sheet, Kwoon Chung Bus Holdings had liabilities of HK$694.3m due within 12 months, and liabilities of HK$2.22b due beyond 12 months. Offsetting these obligations, it had cash of HK$557.7m as well as receivables valued at HK$140.8m due within 12 months. So it has liabilities totalling HK$2.21b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the HK$715.2m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Kwoon Chung Bus Holdings would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is Kwoon Chung Bus Holdings's earnings that will influence how the balance sheet holds up in the future. 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 Kwoon Chung Bus Holdings had a loss before interest and tax, and actually shrunk its revenue by 29%, to HK$1.1b. That makes us nervous, to say the least.

Caveat Emptor

Not only did Kwoon Chung Bus 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$274m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it lost HK$68m in just last twelve months, and it doesn't have much by way of liquid assets. So while it's not wise to assume the company will fail, we do think it's risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Kwoon Chung Bus Holdings (of which 2 shouldn't be ignored!) you should know about.

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.