Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Above all, Kingboard Laminates Holdings Limited (HKG: 1888) carries a debt. But the most important question is: what risk does this debt create?
What risk does debt entail?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
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What is the net debt of Kingboard Laminates Holdings?
The image below, which you can click for more details, shows that in June 2021 Kingboard Laminates Holdings was in debt of HK $ 4.67 billion, up from HK $ 1.77 billion in one year. . However, he has HK $ 3.24 billion in cash to make up for this, which leads to net debt of around HK $ 1.44 billion.
How healthy is Kingboard Laminates Holdings’ balance sheet?
According to the latest published balance sheet, Kingboard Laminates Holdings had a liability of HK $ 10.2 billion due within 12 months and a liability of HK $ 744.1 million due beyond 12 months. In return, he had HK $ 3.24 billion in cash and HK $ 10.9 billion in receivables due within 12 months. He can therefore boast of HK $ 3.23 billion more in liquid assets than total Liabilities.
This surplus suggests that Kingboard Laminates Holdings has a prudent balance sheet and could likely eliminate its debt without too much difficulty.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Kingboard Laminates Holdings has a low net debt to EBITDA ratio of just 0.20. And its EBIT covers its interest costs 183 times. So we’re pretty relaxed about its ultra-conservative use of debt. Even more impressively, Kingboard Laminates Holdings increased its EBIT by 111% year over year. If sustained, this growth will make debt even more manageable in the years to come. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kingboard Laminates Holdings’ ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business can only repay its debts with hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Kingboard Laminates Holdings has recorded free cash flow of 59% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
Fortunately, Kingboard Laminates Holdings’ impressive interest coverage means it has the upper hand on its debt. And the good news doesn’t end there, because its EBIT growth rate also supports this impression! Overall, we don’t think Kingboard Laminates Holdings is taking bad risks as its leverage appears modest. We are therefore not worried about the use of a small leverage on the balance sheet. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Kingboard Laminates Holdings you should know.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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