David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, K. Wah International Holdings Limited (HKG:173) does carry debt. 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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does K. Wah International Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that K. Wah International Holdings had HK$14.0b of debt in June 2024, down from HK$15.0b, one year before. However, it also had HK$7.48b in cash, and so its net debt is HK$6.54b.

How Strong Is K. Wah International Holdings' Balance Sheet?

The latest balance sheet data shows that K. Wah International Holdings had liabilities of HK$12.4b due within a year, and liabilities of HK$15.6b falling due after that. On the other hand, it had cash of HK$7.48b and HK$1.06b worth of receivables due within a year. So its liabilities total HK$19.4b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$5.83b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, K. Wah International 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.

With a net debt to EBITDA ratio of 7.6, it's fair to say K. Wah International Holdings does have a significant amount of debt. However, its interest coverage of 5.7 is reasonably strong, which is a good sign. Importantly, K. Wah International Holdings's EBIT fell a jaw-dropping 36% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine K. Wah International Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, K. Wah International Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

To be frank both K. Wah International Holdings's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We're quite clear that we consider K. Wah International Holdings to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for K. Wah International Holdings you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.