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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. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Nameson Holdings Limited (HKG:1982) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Nameson Holdings
What Is Nameson Holdings's Debt?
As you can see below, Nameson Holdings had HK$1.51b of debt at March 2019, down from HK$2.04b a year prior. However, because it has a cash reserve of HK$414.8m, its net debt is less, at about HK$1.10b.
How Strong Is Nameson Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Nameson Holdings had liabilities of HK$1.64b due within 12 months and liabilities of HK$936.2m due beyond that. Offsetting this, it had HK$414.8m in cash and HK$153.7m in receivables that were due within 12 months. So it has liabilities totalling HK$2.01b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the HK$1.05b 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 definitely think shareholders need to watch this one closely. At the end of the day, Nameson 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.