Is Macau Legend Development (HKG:1680) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Macau Legend Development Limited (HKG:1680) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Macau Legend Development

What Is Macau Legend Development's Net Debt?

The chart below, which you can click on for greater detail, shows that Macau Legend Development had HK$2.61b in debt in June 2023; about the same as the year before. On the flip side, it has HK$122.6m in cash leading to net debt of about HK$2.49b.

How Strong Is Macau Legend Development's Balance Sheet?

According to the last reported balance sheet, Macau Legend Development had liabilities of HK$1.31b due within 12 months, and liabilities of HK$2.20b due beyond 12 months. Offsetting this, it had HK$122.6m in cash and HK$80.6m in receivables that were due within 12 months. So it has liabilities totalling HK$3.30b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$1.23b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Macau Legend Development would likely require a major re-capitalisation if it had to pay its creditors today. 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 Macau Legend Development 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 Macau Legend Development had a loss before interest and tax, and actually shrunk its revenue by 49%, to HK$588m. That makes us nervous, to say the least.

Caveat Emptor

While Macau Legend Development's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping HK$362m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through HK$285m in the last year. So we think this stock is risky, like walking through a dirty dog park with a mask on. 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. Be aware that Macau Legend Development is showing 2 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.