David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Nan Hai Corporation Limited (HKG:680) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 Nan Hai
How Much Debt Does Nan Hai Carry?
You can click the graphic below for the historical numbers, but it shows that Nan Hai had HK$20.2b of debt in June 2019, down from HK$24.5b, one year before. However, it does have HK$4.16b in cash offsetting this, leading to net debt of about HK$16.1b.
How Strong Is Nan Hai's Balance Sheet?
We can see from the most recent balance sheet that Nan Hai had liabilities of HK$32.1b falling due within a year, and liabilities of HK$13.7b due beyond that. Offsetting this, it had HK$4.16b in cash and HK$758.9m in receivables that were due within 12 months. So its liabilities total HK$40.9b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the HK$8.03b 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 definitely think shareholders need to watch this one closely. At the end of the day, Nan Hai 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).