Health Check: How Prudently Does Central Development Holdings (HKG:475) Use Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Central Development Holdings

How Much Debt Does Central Development Holdings Carry?

As you can see below, at the end of March 2024, Central Development Holdings had HK$165.7m of debt, up from HK$149.6m a year ago. Click the image for more detail. However, it also had HK$16.6m in cash, and so its net debt is HK$149.1m.

A Look At Central Development Holdings' Liabilities

According to the last reported balance sheet, Central Development Holdings had liabilities of HK$36.6m due within 12 months, and liabilities of HK$194.9m due beyond 12 months. Offsetting these obligations, it had cash of HK$16.6m as well as receivables valued at HK$4.60m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$210.3m.

This is a mountain of leverage relative to its market capitalization of HK$220.9m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 Central Development Holdings 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 Central Development Holdings had a loss before interest and tax, and actually shrunk its revenue by 24%, to HK$189m. That makes us nervous, to say the least.

Caveat Emptor

Not only did Central Development Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost HK$16m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much 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$10m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Central Development Holdings you should be aware of, and 1 of them can't be ignored.

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.