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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. Importantly, Kingdom Holdings Limited (HKG:528) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Kingdom Holdings
How Much Debt Does Kingdom Holdings Carry?
The image below, which you can click on for greater detail, shows that at June 2019 Kingdom Holdings had debt of CN¥668.4m, up from CN¥597.0m in one year. On the flip side, it has CN¥219.7m in cash leading to net debt of about CN¥448.6m.
How Healthy Is Kingdom Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Kingdom Holdings had liabilities of CN¥1.09b due within 12 months and liabilities of CN¥61.5m due beyond that. Offsetting these obligations, it had cash of CN¥219.7m as well as receivables valued at CN¥299.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥636.9m.
This is a mountain of leverage relative to its market capitalization of CN¥980.3m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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). 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).
Kingdom Holdings has a low net debt to EBITDA ratio of only 1.4. And its EBIT easily covers its interest expense, being 11.7 times the size. So we're pretty relaxed about its super-conservative use of debt. Better yet, Kingdom Holdings grew its EBIT by 429% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kingdom Holdings will need earnings to service that debt. 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.