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Warren Buffett famously said, '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. As with many other companies CEC International Holdings Limited (HKG:759) makes use of debt. But is this debt a concern to shareholders?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for CEC International Holdings
What Is CEC International Holdings's Debt?
You can click the graphic below for the historical numbers, but it shows that CEC International Holdings had HK$388.5m of debt in April 2019, down from HK$432.7m, one year before. However, because it has a cash reserve of HK$49.5m, its net debt is less, at about HK$339.0m.
How Strong Is CEC International Holdings's Balance Sheet?
According to the last reported balance sheet, CEC International Holdings had liabilities of HK$589.2m due within 12 months, and liabilities of HK$6.33m due beyond 12 months. Offsetting these obligations, it had cash of HK$49.5m as well as receivables valued at HK$21.2m due within 12 months. So its liabilities total HK$524.8m more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the HK$276.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt At the end of the day, CEC International Holdings would probably need a major re-capitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.