Is CK Hutchison Holdings (HKG:1) Using Too Much Debt?

By
Simply Wall St
Published
March 19, 2022
SEHK:1
Source: Shutterstock

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.' 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. Importantly, CK Hutchison Holdings Limited (HKG:1) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 CK Hutchison Holdings

What Is CK Hutchison Holdings's Debt?

As you can see below, CK Hutchison Holdings had HK$326.6b of debt at December 2021, down from HK$354.1b a year prior. However, because it has a cash reserve of HK$153.1b, its net debt is less, at about HK$173.4b.

debt-equity-history-analysis
SEHK:1 Debt to Equity History March 19th 2022

How Strong Is CK Hutchison Holdings' Balance Sheet?

We can see from the most recent balance sheet that CK Hutchison Holdings had liabilities of HK$181.4b falling due within a year, and liabilities of HK$387.9b due beyond that. Offsetting this, it had HK$153.1b in cash and HK$57.7b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$358.4b.

This deficit casts a shadow over the HK$219.0b company, like a colossus towering over mere mortals. 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 measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

CK Hutchison Holdings has net debt of just 1.4 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 7.3 times the interest expense over the last year. Even more impressive was the fact that CK Hutchison Holdings grew its EBIT by 120% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, CK Hutchison Holdings recorded free cash flow worth 54% 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

Neither CK Hutchison Holdings's ability to handle its total liabilities nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that CK Hutchison Holdings is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for CK Hutchison Holdings you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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