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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Da Ming International Holdings Limited (HKG:1090) does carry debt. But should shareholders be worried about its use of debt?
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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Da Ming International Holdings
What Is Da Ming International Holdings's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Da Ming International Holdings had CN¥4.86b of debt, an increase on CN¥3.56b, over one year. However, it also had CN¥210.8m in cash, and so its net debt is CN¥4.65b.
A Look At Da Ming International Holdings's Liabilities
According to the last reported balance sheet, Da Ming International Holdings had liabilities of CN¥6.86b due within 12 months, and liabilities of CN¥979.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥210.8m as well as receivables valued at CN¥482.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥7.15b.
This deficit casts a shadow over the CN¥2.09b 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, Da Ming International Holdings would probably need a major re-capitalization if its creditors were to demand repayment.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.