Warren Buffett famously said, '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. Importantly, Skyfame Realty (Holdings) Limited (HKG:59) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Skyfame Realty (Holdings)
What Is Skyfame Realty (Holdings)'s Debt?
You can click the graphic below for the historical numbers, but it shows that Skyfame Realty (Holdings) had CN¥5.50b of debt in June 2019, down from CN¥7.14b, one year before. However, because it has a cash reserve of CN¥1.78b, its net debt is less, at about CN¥3.72b.
How Healthy Is Skyfame Realty (Holdings)'s Balance Sheet?
According to the last reported balance sheet, Skyfame Realty (Holdings) had liabilities of CN¥12.7b due within 12 months, and liabilities of CN¥3.69b due beyond 12 months. On the other hand, it had cash of CN¥1.78b and CN¥655.8m worth of receivables due within a year. So its liabilities total CN¥13.9b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the CN¥7.97b 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, Skyfame Realty (Holdings) would likely require a major re-capitalisation if it had to pay its creditors today.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.