Here's Why CK Hutchison Holdings (HKG:1) Has A Meaningful Debt Burden

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that CK Hutchison Holdings Limited (HKG:1) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for CK Hutchison Holdings

What Is CK Hutchison Holdings's Net Debt?

As you can see below, CK Hutchison Holdings had HK$281.5b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had HK$131.6b in cash, and so its net debt is HK$149.8b.

A Look At CK Hutchison Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that CK Hutchison Holdings had liabilities of HK$166.8b due within 12 months and liabilities of HK$314.7b due beyond that. On the other hand, it had cash of HK$131.6b and HK$31.8b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$318.0b.

The deficiency here weighs heavily on the HK$168.9b 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. After all, CK Hutchison Holdings 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While CK Hutchison Holdings's debt to EBITDA ratio (2.9) suggests that it uses some debt, its interest cover is very weak, at 2.2, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. On a slightly more positive note, CK Hutchison Holdings grew its EBIT at 14% over the last year, further increasing its ability to manage 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 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 86% 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

Mulling over CK Hutchison Holdings's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that CK Hutchison Holdings's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for CK Hutchison Holdings you should be aware of.

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.

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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.