We Think HC Group (HKG:2280) Has A Fair Chunk Of Debt

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. As with many other companies HC Group Inc. (HKG:2280) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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, 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.

See our latest analysis for HC Group

What Is HC Group's Net Debt?

As you can see below, HC Group had CN¥1.00b of debt at December 2021, down from CN¥1.24b a year prior. However, because it has a cash reserve of CN¥365.7m, its net debt is less, at about CN¥636.8m.

How Strong Is HC Group's Balance Sheet?

According to the last reported balance sheet, HC Group had liabilities of CN¥1.50b due within 12 months, and liabilities of CN¥586.3m due beyond 12 months. Offsetting this, it had CN¥365.7m in cash and CN¥1.52b in receivables that were due within 12 months. So its liabilities total CN¥198.3m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because HC Group is worth CN¥484.5m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since HC Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year HC Group wasn't profitable at an EBIT level, but managed to grow its revenue by 20%, to CN¥17b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, HC Group had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥46m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥188m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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. Be aware that HC Group is showing 3 warning signs in our investment analysis , and 1 of those is concerning...

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.