Is Macau Legend Development (HKG:1680) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Macau Legend Development Limited (HKG:1680) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Macau Legend Development

What Is Macau Legend Development's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Macau Legend Development had debt of HK$2.53b, up from HK$2.20b in one year. However, because it has a cash reserve of HK$98.4m, its net debt is less, at about HK$2.43b.

A Look At Macau Legend Development's Liabilities

Zooming in on the latest balance sheet data, we can see that Macau Legend Development had liabilities of HK$3.53b due within 12 months and liabilities of HK$231.0m due beyond that. On the other hand, it had cash of HK$98.4m and HK$155.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$3.51b.

This deficit casts a shadow over the HK$2.14b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Macau Legend Development would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Macau Legend Development'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 Macau Legend Development wasn't profitable at an EBIT level, but managed to grow its revenue by 33%, to HK$1.2b. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Macau Legend Development's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable HK$559m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of HK$398m over the last twelve months. That means it's on the risky side of things. 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 3 warning signs for Macau Legend Development (of which 2 shouldn't be ignored!) you should know about.

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.