Stock Analysis

Here's Why Hung Fook Tong Group Holdings (HKG:1446) Can Manage Its Debt Responsibly

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SEHK:1446
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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. We note that Hung Fook Tong Group Holdings Limited (HKG:1446) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Hung Fook Tong Group Holdings

How Much Debt Does Hung Fook Tong Group Holdings Carry?

The image below, which you can click on for greater detail, shows that Hung Fook Tong Group Holdings had debt of HK$41.6m at the end of December 2020, a reduction from HK$93.6m over a year. But it also has HK$134.9m in cash to offset that, meaning it has HK$93.3m net cash.

debt-equity-history-analysis
SEHK:1446 Debt to Equity History April 20th 2021

A Look At Hung Fook Tong Group Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Hung Fook Tong Group Holdings had liabilities of HK$395.9m due within 12 months and liabilities of HK$104.0m due beyond that. Offsetting this, it had HK$134.9m in cash and HK$45.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$319.1m.

This deficit is considerable relative to its market capitalization of HK$373.9m, so it does suggest shareholders should keep an eye on Hung Fook Tong Group Holdings' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Hung Fook Tong Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Hung Fook Tong Group Holdings grew its EBIT by 252% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hung Fook Tong Group Holdings'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hung Fook Tong Group Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Hung Fook Tong Group Holdings recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although Hung Fook Tong Group Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$93.3m. And we liked the look of last year's 252% year-on-year EBIT growth. So we don't have any problem with Hung Fook Tong Group Holdings's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Hung Fook Tong Group 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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