The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Dream International Limited (HKG:1126) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Dream International
How Much Debt Does Dream International Carry?
As you can see below, Dream International had HK$150.0m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. But it also has HK$426.8m in cash to offset that, meaning it has HK$276.8m net cash.
How Strong Is Dream International's Balance Sheet?
We can see from the most recent balance sheet that Dream International had liabilities of HK$794.8m falling due within a year, and liabilities of HK$27.1m due beyond that. Offsetting these obligations, it had cash of HK$426.8m as well as receivables valued at HK$602.5m due within 12 months. So it actually has HK$207.4m more liquid assets than total liabilities.
This short term liquidity is a sign that Dream International could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Dream International boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that Dream International has seen its EBIT plunge 16% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Dream International will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Dream International may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Dream International produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing up
While it is always sensible to investigate a company's debt, in this case Dream International has HK$276.8m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in HK$417m. So we don't have any problem with Dream International's use of debt. 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 Dream International you should be aware of.
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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
2020-02-07 06:05:01Z
https://finance.yahoo.com/news/dream-international-hkg-1126-pretty-055316824.html
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