Here's Why Hong Kong Shanghai Alliance Holdings (HKG:1001) Has A Meaningful Debt Burden

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Hong Kong Shanghai Alliance Holdings Limited (HKG:1001) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Hong Kong Shanghai Alliance Holdings

How Much Debt Does Hong Kong Shanghai Alliance Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that Hong Kong Shanghai Alliance Holdings had HK$1.43b of debt in September 2020, down from HK$1.57b, one year before. However, it also had HK$124.3m in cash, and so its net debt is HK$1.31b.

A Look At Hong Kong Shanghai Alliance Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Hong Kong Shanghai Alliance Holdings had liabilities of HK$979.9m due within 12 months and liabilities of HK$917.9m due beyond that. Offsetting this, it had HK$124.3m in cash and HK$331.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$1.44b.

This deficit casts a shadow over the HK$163.5m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Hong Kong Shanghai Alliance Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Weak interest cover of 0.77 times and a disturbingly high net debt to EBITDA ratio of 15.8 hit our confidence in Hong Kong Shanghai Alliance Holdings like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that Hong Kong Shanghai Alliance Holdings achieved a positive EBIT of HK$53m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But it is Hong Kong Shanghai Alliance Holdings'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Hong Kong Shanghai Alliance Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both Hong Kong Shanghai Alliance Holdings's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, it seems to us that Hong Kong Shanghai Alliance 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. We've identified 3 warning signs with Hong Kong Shanghai Alliance Holdings (at least 2 which are 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.

If you decide to trade Hong Kong Shanghai Alliance Holdings, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.