Does Central Development Holdings (HKG:475) Have A Healthy Balance Sheet?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Central Development Holdings Limited (HKG:475) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that 475 is potentially overvalued!

What Is Central Development Holdings's Debt?

The image below, which you can click on for greater detail, shows that Central Development Holdings had debt of HK$129.5m at the end of September 2022, a reduction from HK$137.9m over a year. However, because it has a cash reserve of HK$18.5m, its net debt is less, at about HK$111.0m.

How Healthy Is Central Development Holdings' Balance Sheet?

The latest balance sheet data shows that Central Development Holdings had liabilities of HK$36.1m due within a year, and liabilities of HK$133.4m falling due after that. Offsetting these obligations, it had cash of HK$18.5m as well as receivables valued at HK$38.7m due within 12 months. So its liabilities total HK$112.3m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Central Development Holdings is worth HK$271.3m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is Central Development 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.

In the last year Central Development Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 130%, to HK$258m. So its pretty obvious shareholders are hoping for more growth!

Caveat Emptor

While we can certainly appreciate Central Development Holdings's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost HK$17m 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 HK$29m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Central Development Holdings (of which 1 shouldn't be ignored!) 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.

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

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.