CK Hutchison Holdings (HKG:1) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that CK Hutchison Holdings Limited (HKG:1) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for CK Hutchison Holdings

What Is CK Hutchison Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that CK Hutchison Holdings had HK$288.3b of debt in December 2022, down from HK$327.7b, one year before. On the flip side, it has HK$139.0b in cash leading to net debt of about HK$149.3b.

How Healthy Is CK Hutchison Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CK Hutchison Holdings had liabilities of HK$176.5b due within 12 months and liabilities of HK$324.6b due beyond that. Offsetting these obligations, it had cash of HK$139.0b as well as receivables valued at HK$32.7b due within 12 months. So its liabilities total HK$329.4b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$194.9b 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 definitely think shareholders need to watch this one closely. At the end of the day, CK Hutchison 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

CK Hutchison Holdings has a debt to EBITDA ratio of 3.2 and its EBIT covered its interest expense 2.8 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Even worse, CK Hutchison Holdings saw its EBIT tank 22% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CK Hutchison 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, CK Hutchison Holdings recorded free cash flow worth a fulsome 93% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

On the face of it, CK Hutchison Holdings'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 on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, it seems to us that CK Hutchison Holdings's balance sheet is really quite a risk to the business. 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. For example CK Hutchison Holdings has 3 warning signs (and 1 which shouldn't be ignored) we think 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.