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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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Ka Shui International Holdings Limited (HKG:822) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Ka Shui International Holdings
What Is Ka Shui International Holdings's Debt?
As you can see below, Ka Shui International Holdings had HK$253.9m of debt at June 2019, down from HK$397.9m a year prior. However, it also had HK$203.8m in cash, and so its net debt is HK$50.1m.
A Look At Ka Shui International Holdings's Liabilities
According to the last reported balance sheet, Ka Shui International Holdings had liabilities of HK$503.5m due within 12 months, and liabilities of HK$84.0m due beyond 12 months. Offsetting this, it had HK$203.8m in cash and HK$316.6m in receivables that were due within 12 months. So its liabilities total HK$67.2m more than the combination of its cash and short-term receivables.
Ka Shui International Holdings has a market capitalization of HK$299.4m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Ka Shui International Holdings has a low net debt to EBITDA ratio of only 0.23. And its EBIT easily covers its interest expense, being 10.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Ka Shui International Holdings grew its EBIT by 303% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Ka Shui International Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.