Health Check: How Prudently Does Hop Fung Group Holdings (HKG:2320) Use 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. As with many other companies Hop Fung Group Holdings Limited (HKG:2320) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

View our latest analysis for Hop Fung Group Holdings

What Is Hop Fung Group Holdings's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Hop Fung Group Holdings had debt of HK$282.3m, up from HK$216.9m in one year. But it also has HK$296.0m in cash to offset that, meaning it has HK$13.7m net cash.

How Strong Is Hop Fung Group Holdings' Balance Sheet?

The latest balance sheet data shows that Hop Fung Group Holdings had liabilities of HK$373.7m due within a year, and liabilities of HK$208.2m falling due after that. On the other hand, it had cash of HK$296.0m and HK$200.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$85.8m.

This deficit isn't so bad because Hop Fung Group Holdings is worth HK$220.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Hop Fung Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! 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 Hop Fung Group 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 Hop Fung Group Holdings had a loss before interest and tax, and actually shrunk its revenue by 13%, to HK$1.0b. That's not what we would hope to see.

So How Risky Is Hop Fung Group Holdings?

Although Hop Fung Group Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of HK$1.4m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. Case in point: We've spotted 3 warning signs for Hop Fung Group Holdings you should be aware of, and 1 of them is concerning.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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