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.' 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. We can see that Hor Kew Corporation Limited (SGX:BBP) does use debt in its business. But the real question is whether this debt is making the company risky.
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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Hor Kew Carry?
As you can see below, Hor Kew had S$70.4m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of S$29.4m, its net debt is less, at about S$41.0m.
A Look At Hor Kew's Liabilities
Zooming in on the latest balance sheet data, we can see that Hor Kew had liabilities of S$94.0m due within 12 months and liabilities of S$10.6m due beyond that. On the other hand, it had cash of S$29.4m and S$17.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$57.7m.
The deficiency here weighs heavily on the S$12.5m 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, Hor Kew 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 Hor Kew'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 Hor Kew had a loss before interest and tax, and actually shrunk its revenue by 23%, to S$50m. To be frank that doesn't bode well.
Not only did Hor Kew'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 S$4.1m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. But on the bright side the company actually produced a statutory profit of S$332k and free cash flow of S$703k. So there is arguably potential that the company is going to turn things around. 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. Case in point: We've spotted 4 warning signs for Hor Kew you should be aware of, and 2 of them shouldn't be ignored.
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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