Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, NWS Holdings Limited (HKG:659) is in debt. But the more important question is: what risk does this debt create?
When is debt a problem?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
Check out our latest analysis for NWS Holdings
How much debt does NWS Holdings have?
The image below, which you can click on for more details, shows that NWS Holdings had HK$20.1 billion in debt at the end of December 2021, a reduction from HK$25.4 billion on a year. However, its balance sheet shows it holds HK$28.2 billion in cash, so it actually has $8.05 billion in net cash.
How strong is NWS Holdings’ balance sheet?
According to the latest published balance sheet, NWS Holdings had liabilities of HK$51.5 billion due within 12 months and liabilities of HK$40.9 billion due beyond 12 months. In return, it had HK$28.2 billion in cash and HK$8.78 billion in debt due within 12 months. Thus, its liabilities total HK$55.5 billion more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the HK$27.4 billion business itself, like a child struggling under the weight of a huge backpack full of books, his sports gear and a trumpet. So we definitely think shareholders need to watch this one closely. After all, NWS Holdings would likely need a major recapitalization if it were to pay its creditors today. Since NWS Holdings has more cash than debt, we’re pretty confident that it can manage its debt, despite having a lot of debt in total. When analyzing debt levels, the balance sheet is the obvious starting point. But future earnings, more than anything, will determine NWS Holdings’ ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Last year, NWS Holdings was not profitable in terms of EBIT, but managed to increase its turnover by 18%, to 30 billion Hong Kong dollars. We generally like to see faster growth from unprofitable companies, but each in its own way.
So how risky is NWS Holdings?
Although NWS Holdings posted a loss in earnings before interest and tax (EBIT) over the past twelve months, it made a statutory profit of HK$1.9 billion. So taking that at face value, and considering the money, we don’t think it’s very risky in the short term. Given the lack of transparency around future revenue (and cash flow), we’re nervous about this one, until it hits its first big sales. For us, this is a high risk game. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, NWS Holdings has 2 warning signs (and 1 which is a little worrying) that we think you should know about.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeright now.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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