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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.' 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 Evergreen Products Group Limited (HKG:1962) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Evergreen Products Group
What Is Evergreen Products Group's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Evergreen Products Group had debt of HK$799.5m, up from HK$638.2m in one year. On the flip side, it has HK$60.6m in cash leading to net debt of about HK$738.9m.
How Strong Is Evergreen Products Group's Balance Sheet?
The latest balance sheet data shows that Evergreen Products Group had liabilities of HK$849.0m due within a year, and liabilities of HK$14.4m falling due after that. On the other hand, it had cash of HK$60.6m and HK$206.9m worth of receivables due within a year. So its liabilities total HK$595.9m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Evergreen Products Group is worth HK$1.12b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.