Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Modern Living Investments Holdings Limited (HKG:8426) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Modern Living Investments Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that Modern Living Investments Holdings had debt of HK$32.8m at the end of June 2019, a reduction from HK$41.7m over a year. However, its balance sheet shows it holds HK$55.8m in cash, so it actually has HK$22.9m net cash.
A Look At Modern Living Investments Holdings's Liabilities
We can see from the most recent balance sheet that Modern Living Investments Holdings had liabilities of HK$75.4m falling due within a year, and liabilities of HK$1.42m due beyond that. Offsetting this, it had HK$55.8m in cash and HK$93.6m in receivables that were due within 12 months. So it actually has HK$72.6m more liquid assets than total liabilities.
This luscious liquidity implies that Modern Living Investments Holdings's balance sheet is sturdy like a giant sequoia tree. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Succinctly put, Modern Living Investments Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact Modern Living Investments Holdings's saving grace is its low debt levels, because its EBIT has tanked 39% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Modern Living Investments Holdings'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 Modern Living Investments Holdings 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. Over the last three years, Modern Living Investments Holdings recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for and improvement.
While it is always sensible to investigate a company's debt, in this case Modern Living Investments Holdings has HK$22.9m in net cash and a decent-looking balance sheet. So we don't have any problem with Modern Living Investments Holdings's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Modern Living Investments Holdings insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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