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.' 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. As with many other companies Ozner Water International Holding Limited (HKG:2014) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Ozner Water International Holding
What Is Ozner Water International Holding's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Ozner Water International Holding had CN¥2.01b of debt, an increase on CN¥1.89b, over one year. On the flip side, it has CN¥326.0m in cash leading to net debt of about CN¥1.69b.
A Look At Ozner Water International Holding's Liabilities
We can see from the most recent balance sheet that Ozner Water International Holding had liabilities of CN¥3.23b falling due within a year, and liabilities of CN¥653.8m due beyond that. Offsetting these obligations, it had cash of CN¥326.0m as well as receivables valued at CN¥720.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.84b.
Given this deficit is actually higher than the company's market capitalization of CN¥2.47b, we think shareholders really should watch Ozner Water International Holding's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.