Stock Analysis

Is Central Development Holdings (HKG:475) Using Too Much Debt?

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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 Central Development Holdings Limited (HKG:475) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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.

Check out our latest analysis for Central Development Holdings

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, it also had HK$18.9m in cash, and so its net debt is HK$110.6m.

SEHK:475 Debt to Equity History March 15th 2023

How Strong 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$18.9m as well as receivables valued at HK$7.57m due within 12 months. So it has liabilities totalling HK$143.0m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of HK$158.9m, so it does suggest shareholders should keep an eye on Central Development Holdings' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. 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 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

Even though Central Development Holdings managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost a very considerable 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. However, it doesn't help that it burned through HK$1.4m of cash over the last year. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Central Development Holdings (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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