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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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. As with many other companies Golden Power Group Holdings Limited (HKG:3919) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Golden Power Group Holdings
What Is Golden Power Group Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Golden Power Group Holdings had debt of HK$193.2m, up from HK$106.4m in one year. However, it does have HK$47.9m in cash offsetting this, leading to net debt of about HK$145.3m.
How Strong Is Golden Power Group Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Golden Power Group Holdings had liabilities of HK$239.4m due within 12 months and liabilities of HK$57.1m due beyond that. On the other hand, it had cash of HK$47.9m and HK$55.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$193.1m.
The deficiency here weighs heavily on the HK$120.0m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet." So we'd watch its balance sheet closely, without a doubt At the end of the day, Golden Power Group 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).