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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Major Holdings Limited (HKG:1389) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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, 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.
Check out our latest analysis for Major Holdings
What Is Major Holdings's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Major Holdings had HK$13.5m of debt in March 2019, down from HK$29.0m, one year before. However, it also had HK$8.88m in cash, and so its net debt is HK$4.63m.
How Strong Is Major Holdings's Balance Sheet?
According to the last reported balance sheet, Major Holdings had liabilities of HK$34.3m due within 12 months, and liabilities of HK$3.15m due beyond 12 months. On the other hand, it had cash of HK$8.88m and HK$13.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$15.2m.
Of course, Major Holdings has a market capitalization of HK$233.3m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Given net debt is only 1.5 times EBITDA, it is initially surprising to see that Major Holdings's EBIT has low interest coverage of 0.25 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Shareholders should be aware that Major Holdings's EBIT was down 97% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Major 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.