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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. We can see that Road King Infrastructure Limited (HKG:1098) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
See our latest analysis for Road King Infrastructure
What Is Road King Infrastructure's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Road King Infrastructure had debt of HK$28.8b, up from HK$22.1b in one year. However, it also had HK$14.0b in cash, and so its net debt is HK$14.8b.
How Strong Is Road King Infrastructure's Balance Sheet?
According to the last reported balance sheet, Road King Infrastructure had liabilities of HK$42.8b due within 12 months, and liabilities of HK$16.1b due beyond 12 months. Offsetting these obligations, it had cash of HK$14.0b as well as receivables valued at HK$4.69b due within 12 months. So it has liabilities totalling HK$40.1b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the HK$10.1b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Road King Infrastructure would probably need a major re-capitalization if its creditors were to demand repayment.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.