Shenzhen HeungKong HoldingLtd (SHSE:600162) Has A Somewhat Strained Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Shenzhen HeungKong Holding Co.,Ltd (SHSE:600162) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Shenzhen HeungKong HoldingLtd

What Is Shenzhen HeungKong HoldingLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Shenzhen HeungKong HoldingLtd had CN¥3.64b of debt in September 2023, down from CN¥5.63b, one year before. However, it does have CN¥1.74b in cash offsetting this, leading to net debt of about CN¥1.90b.

How Healthy Is Shenzhen HeungKong HoldingLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen HeungKong HoldingLtd had liabilities of CN¥12.1b due within 12 months and liabilities of CN¥2.94b due beyond that. Offsetting this, it had CN¥1.74b in cash and CN¥809.3m in receivables that were due within 12 months. So its liabilities total CN¥12.5b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥5.26b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Shenzhen HeungKong HoldingLtd would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Shenzhen HeungKong HoldingLtd's net debt is 2.8 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. Shareholders should be aware that Shenzhen HeungKong HoldingLtd's EBIT was down 35% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shenzhen HeungKong HoldingLtd 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Shenzhen HeungKong HoldingLtd recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

On the face of it, Shenzhen HeungKong HoldingLtd's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, it seems to us that Shenzhen HeungKong HoldingLtd's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Shenzhen HeungKong HoldingLtd (at least 1 which is significant) , and understanding them should be part of your investment process.

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

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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.