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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. 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. Importantly, Shun Ho Holdings Limited (HKG:253) does carry debt. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Shun Ho Holdings
How Much Debt Does Shun Ho Holdings Carry?
As you can see below, Shun Ho Holdings had HK$989.6m of debt at June 2019, down from HK$1.67b a year prior. On the flip side, it has HK$621.1m in cash leading to net debt of about HK$368.5m.
How Healthy Is Shun Ho Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Shun Ho Holdings had liabilities of HK$372.3m due within 12 months and liabilities of HK$908.8m due beyond that. Offsetting this, it had HK$621.1m in cash and HK$20.0m in receivables that were due within 12 months. So it has liabilities totalling HK$639.9m more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the HK$411.0m 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. After all, Shun Ho Holdings would likely require a major re-capitalisation if it had to pay its creditors today.
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.