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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, EFT Solutions Holdings Limited (HKG:8062) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for EFT Solutions Holdings
How Much Debt Does EFT Solutions Holdings Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 EFT Solutions Holdings had HK$207.2m of debt, an increase on HK$5.00m, over one year. On the flip side, it has HK$38.2m in cash leading to net debt of about HK$169.0m.
How Healthy Is EFT Solutions Holdings's Balance Sheet?
We can see from the most recent balance sheet that EFT Solutions Holdings had liabilities of HK$97.3m falling due within a year, and liabilities of HK$138.0m due beyond that. Offsetting this, it had HK$38.2m in cash and HK$55.2m in receivables that were due within 12 months. So it has liabilities totalling HK$141.9m more than its cash and near-term receivables, combined.
This deficit casts a shadow over the HK$91.2m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, EFT Solutions 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). 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).