Is Casablanca Group (HKG:2223) Using Too Much Debt?

Simply Wall St

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Casablanca Group Limited (HKG:2223) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Casablanca Group

What Is Casablanca Group's Debt?

The image below, which you can click on for greater detail, shows that Casablanca Group had debt of HK$8.54m at the end of June 2019, a reduction from HK$11.9m over a year. But on the other hand it also has HK$167.8m in cash, leading to a HK$159.2m net cash position.

SEHK:2223 Historical Debt, September 11th 2019

A Look At Casablanca Group's Liabilities

The latest balance sheet data shows that Casablanca Group had liabilities of HK$91.5m due within a year, and liabilities of HK$14.4m falling due after that. Offsetting these obligations, it had cash of HK$167.8m as well as receivables valued at HK$64.4m due within 12 months. So it can boast HK$126.3m more liquid assets than total liabilities.

This excess liquidity is a great indication that Casablanca Group's balance sheet is just as strong as racists are weak. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, Casablanca Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Casablanca Group grew its EBIT by 377% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is Casablanca Group's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Casablanca Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Casablanca Group recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Casablanca Group has HK$159m in net cash and a decent-looking balance sheet. And we liked the look of last year's 377% year-on-year EBIT growth. So is Casablanca Group's debt a risk? It doesn't seem so to us. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Casablanca Group's dividend history, without delay!

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

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. Thank you for reading.