Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Kingboard Holdings Limited (HKG:148) 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. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Kingboard Holdings's Debt?

The chart below, which you can click on for greater detail, shows that Kingboard Holdings had HK$23.2b in debt in June 2024; about the same as the year before. However, because it has a cash reserve of HK$11.3b, its net debt is less, at about HK$11.9b.

How Strong Is Kingboard Holdings' Balance Sheet?

The latest balance sheet data shows that Kingboard Holdings had liabilities of HK$19.8b due within a year, and liabilities of HK$15.0b falling due after that. On the other hand, it had cash of HK$11.3b and HK$12.7b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$10.8b.

This deficit isn't so bad because Kingboard Holdings is worth HK$20.3b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Kingboard Holdings's net debt is sitting at a very reasonable 1.8 times its EBITDA, while its EBIT covered its interest expense just 4.7 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. We saw Kingboard Holdings grow its EBIT by 2.5% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Kingboard Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Kingboard Holdings's free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both Kingboard Holdings's level of total liabilities and its conversion of EBIT to free cash flow were discouraging. At least its net debt to EBITDA gives us reason to be optimistic. Looking at all the angles mentioned above, it does seem to us that Kingboard Holdings is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Kingboard Holdings (of which 1 doesn't sit too well with us!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.