Is Chi Ho Development Holdings (HKG:8423) A Risky Investment?

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 Chi Ho Development Holdings Limited (HKG:8423) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Chi Ho Development Holdings

What Is Chi Ho Development Holdings's Debt?

As you can see below, Chi Ho Development Holdings had HK$89.7m of debt, at March 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have HK$44.0m in cash offsetting this, leading to net debt of about HK$45.8m.

How Healthy Is Chi Ho Development Holdings' Balance Sheet?

The latest balance sheet data shows that Chi Ho Development Holdings had liabilities of HK$194.4m due within a year, and liabilities of HK$2.34m falling due after that. Offsetting these obligations, it had cash of HK$44.0m as well as receivables valued at HK$234.6m due within 12 months. So it can boast HK$81.8m more liquid assets than total liabilities.

This excess liquidity is a great indication that Chi Ho Development Holdings' balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Chi Ho Development Holdings has net debt worth 2.3 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.7 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, Chi Ho Development Holdings grew its EBIT by 45% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Chi Ho Development Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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, Chi Ho Development Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Happily, Chi Ho Development Holdings's impressive EBIT growth rate implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that Chi Ho Development Holdings takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. For instance, we've identified 2 warning signs for Chi Ho Development Holdings that 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.