David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Kiddieland International Limited (HKG:3830) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Kiddieland International's Debt?
The image below, which you can click on for greater detail, shows that at April 2019 Kiddieland International had debt of HK$138.2m, up from HK$123.2m in one year. However, it does have HK$19.5m in cash offsetting this, leading to net debt of about HK$118.7m.
A Look At Kiddieland International's Liabilities
According to the last reported balance sheet, Kiddieland International had liabilities of HK$188.7m due within 12 months, and liabilities of HK$4.40m due beyond 12 months. On the other hand, it had cash of HK$19.5m and HK$27.6m worth of receivables due within a year. So it has liabilities totalling HK$146.0m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Kiddieland International has a market capitalization of HK$255.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Kiddieland International 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.
In the last year Kiddieland International actually shrunk its revenue by 9.8%, to HK$289m. That's not what we would hope to see.
Importantly, Kiddieland International had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost HK$6.4m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled HK$19m in negative free cash flow over the last twelve months. So in short it's a really risky stock. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Kiddieland International's profit, revenue, and operating cashflow have changed over the last few years.
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.
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