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. It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies HongDa Financial Holding Limited (HKG:1822) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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.
What Is HongDa Financial Holding’s Debt?
As you can see below, HongDa Financial Holding had HK$1.02b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it also had HK$27.5m in cash, and so its net debt is HK$996.4m.
A Look At HongDa Financial Holding’s Liabilities
We can see from the most recent balance sheet that HongDa Financial Holding had liabilities of HK$659.3m falling due within a year, and liabilities of HK$539.9m due beyond that. On the other hand, it had cash of HK$27.5m and HK$677.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$494.0m.
The deficiency here weighs heavily on the HK$68.1m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we’d watch its balance sheet closely, without a doubt. After all, HongDa Financial Holding would likely require a major re-capitalisation if it had to pay its creditors today. There’s no doubt that we learn most about debt from the balance sheet. But it is HongDa Financial Holding’s earnings that will influence how the balance sheet holds up in the future. 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.
In the last year HongDa Financial Holding had negative earnings before interest and tax, and actually shrunk its revenue by 77%, to HK$659m. That makes us nervous, to say the least.
While HongDa Financial Holding’s falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable HK$395m at the EBIT level. Reflecting on this and the significant total liabilities, it’s hard to know what to say about the stock because of our intense dis-affinity for it. Like every long-shot we’re sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it lost HK$424m in the last year. So we think buying this stock is risky, like walking through a minefield with a mask on. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example – HongDa Financial Holding has 5 warning signs (and 2 which don’t sit too well with us) we think you should know about.
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.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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