Kong Sun Holdings (HKG:295) Debt use could be seen as risky

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Kong Sun Holdings Limited (HKG:295) has a debt on its balance sheet. But the real question is whether this debt makes the business risky.

When is debt a problem?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.

Check out our latest analysis for Kong Sun Holdings

How much debt does Kong Sun Holdings have?

The image below, which you can click on for more details, shows that Kong Sun Holdings had 3.67 billion Canadian yen in debt at the end of December 2021, a reduction from 6.56 billion yen Canadians over one year. On the other hand, it has 699.6 million national yen of liquid assets, resulting in a net debt of approximately 2.97 billion national yen.

SEHK: 295 Historical Debt to Equity May 26, 2022

How healthy is Kong Sun Holdings’ balance sheet?

We can see from the most recent balance sheet that Kong Sun Holdings had liabilities of 2.56 trillion yen maturing within one year, and liabilities of 1.91 trillion yen due beyond. In compensation for these obligations, it had cash of 699.6 million yen as well as receivables valued at 2.29 billion yen due within 12 months. It therefore has liabilities totaling 1.48 billion Canadian yen more than its cash and short-term receivables, combined.

This deficit casts a shadow over the 599.6 million yen business, like a colossus towering above mere mortals. So we definitely think shareholders need to watch this one closely. After all, Kong Sun Holdings would likely need a major recapitalization if it were to pay its creditors today.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.

While we are not concerned about Kong Sun Holdings’ net debt to EBITDA ratio of 4.9, we believe its extremely low interest coverage of 0.66x is a sign of high leverage. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company lately. Worse still, Kong Sun Holdings’ EBIT was down 46% from a year ago. If earnings continue to follow this trajectory, paying off that debt will be harder than convincing us to run a marathon in the rain. There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of Kong Sun Holdings that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Fortunately for all shareholders, Kong Sun Holdings has actually produced more free cash flow than EBIT for the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our point of view

At first glance, Kong Sun Holdings’ EBIT growth rate left us hesitant about the stock, and its level of total liabilities was no more attractive than the single empty restaurant on the busiest night in the world. ‘year. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Overall, it seems to us that the balance sheet of Kong Sun Holdings is really a risk for the company. We are therefore almost as suspicious of this stock as a hungry kitten of falling into its owner’s fish pond: once bitten, twice shy, as they say. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example, we found 3 warning signs for Kong Sun Holdings (1 is concerning!) that you should be aware of before investing here.

If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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