Here's Why Kwan Yong Holdings (HKG:9998) Can Manage Its Debt Responsibly

Simply Wall St

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. Importantly, Kwan Yong Holdings Limited (HKG:9998) does carry debt. But the more important question is: how much risk is that debt creating?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Kwan Yong Holdings

How Much Debt Does Kwan Yong Holdings Carry?

As you can see below, Kwan Yong Holdings had S$2.26m of debt at December 2019, down from S$4.31m a year prior. However, it does have S$9.45m in cash offsetting this, leading to net cash of S$7.19m.

SEHK:9998 Historical Debt April 9th 2020

A Look At Kwan Yong Holdings's Liabilities

According to the last reported balance sheet, Kwan Yong Holdings had liabilities of S$61.7m due within 12 months, and liabilities of S$2.25m due beyond 12 months. On the other hand, it had cash of S$9.45m and S$69.4m worth of receivables due within a year. So it actually has S$14.9m more liquid assets than total liabilities.

This excess liquidity suggests that Kwan Yong Holdings is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Kwan Yong Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Kwan Yong Holdings has boosted its EBIT by 49%, thus reducing the spectre of future debt repayments. 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 Kwan Yong Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Kwan Yong Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Considering the last three years, Kwan Yong Holdings actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While it is always sensible to investigate a company's debt, in this case Kwan Yong Holdings has S$7.19m in net cash and a decent-looking balance sheet. And we liked the look of last year's 49% year-on-year EBIT growth. So we don't think Kwan Yong Holdings's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider risks, for instance. Every company has them, and we've spotted 3 warning signs for Kwan Yong Holdings you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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