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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that EGL Holdings Company Limited (HKG:6882) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for EGL Holdings
What Is EGL Holdings's Net Debt?
As you can see below, at the end of June 2019, EGL Holdings had HK$320.8m of debt, up from HK$286.4m a year ago. Click the image for more detail. On the flip side, it has HK$260.1m in cash leading to net debt of about HK$60.6m.
How Strong Is EGL Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that EGL Holdings had liabilities of HK$418.0m due within 12 months and liabilities of HK$312.9m due beyond that. Offsetting these obligations, it had cash of HK$260.1m as well as receivables valued at HK$36.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$434.0m.
This deficit casts a shadow over the HK$266.3m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt At the end of the day, EGL Holdings would probably need a major re-capitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).