Would Central Development Holdings (HKG:475) Be Better Off With Less Debt?

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 note that Central Development Holdings Limited (HKG:475) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Central Development Holdings

How Much Debt Does Central Development Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Central Development Holdings had HK$137.9m of debt, an increase on HK$113.8m, over one year. However, it does have HK$43.9m in cash offsetting this, leading to net debt of about HK$94.1m.

A Look At Central Development Holdings' Liabilities

According to the last reported balance sheet, Central Development Holdings had liabilities of HK$50.2m due within 12 months, and liabilities of HK$140.8m due beyond 12 months. Offsetting these obligations, it had cash of HK$43.9m as well as receivables valued at HK$16.0m due within 12 months. So its liabilities total HK$131.1m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Central Development Holdings has a market capitalization of HK$267.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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 wasn't profitable at an EBIT level, but managed to grow its revenue by 92%, to HK$112m. Shareholders probably have their fingers crossed that it can grow its way to profits.

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$26m 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. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through HK$24m of cash over the last year. 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. Case in point: We've spotted 3 warning signs for Central Development Holdings you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.