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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. 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 New Provenance Everlasting Holdings Limited (HKG:2326) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.
View our latest analysis for New Provenance Everlasting Holdings
What Is New Provenance Everlasting Holdings's Net Debt?
You can click the graphic below for the historical numbers, but it shows that New Provenance Everlasting Holdings had HK$412.6m of debt in March 2019, down from HK$851.2m, one year before. However, it does have HK$93.0m in cash offsetting this, leading to net debt of about HK$319.6m.
How Strong Is New Provenance Everlasting Holdings's Balance Sheet?
The latest balance sheet data shows that New Provenance Everlasting Holdings had liabilities of HK$487.6m due within a year, and liabilities of HK$66.0k falling due after that. On the other hand, it had cash of HK$93.0m and HK$541.9m worth of receivables due within a year. So it actually has HK$147.2m more liquid assets than total liabilities.
It's good to see that New Provenance Everlasting Holdings has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.