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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. 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 iDreamSky Technology Holdings Limited (HKG:1119) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for iDreamSky Technology Holdings
How Much Debt Does iDreamSky Technology Holdings Carry?
You can click the graphic below for the historical numbers, but it shows that iDreamSky Technology Holdings had CN¥996.8m of debt in June 2019, down from CN¥1.12b, one year before. On the flip side, it has CN¥555.6m in cash leading to net debt of about CN¥441.2m.
How Strong Is iDreamSky Technology Holdings's Balance Sheet?
The latest balance sheet data shows that iDreamSky Technology Holdings had liabilities of CN¥1.61b due within a year, and liabilities of CN¥143.0m falling due after that. Offsetting this, it had CN¥555.6m in cash and CN¥1.44b in receivables that were due within 12 months. So it can boast CN¥240.5m more liquid assets than total liabilities.
This surplus suggests that iDreamSky Technology Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
iDreamSky Technology Holdings's net debt is only 0.68 times its EBITDA. And its EBIT easily covers its interest expense, being 12.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that iDreamSky Technology Holdings has boosted its EBIT by 73%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if iDreamSky Technology Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.