Hop Fung Group Holdings (HKG:2320) Has Debt But No Earnings; Should You Worry?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Hop Fung Group Holdings Limited (HKG:2320) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

Check out the opportunities and risks within the HK Packaging industry.

What Is Hop Fung Group Holdings's Debt?

The image below, which you can click on for greater detail, shows that Hop Fung Group Holdings had debt of HK$145.6m at the end of June 2022, a reduction from HK$263.0m over a year. But on the other hand it also has HK$200.8m in cash, leading to a HK$55.1m net cash position.

How Healthy Is Hop Fung Group Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hop Fung Group Holdings had liabilities of HK$193.8m due within 12 months and liabilities of HK$110.7m due beyond that. Offsetting this, it had HK$200.8m in cash and HK$84.3m in receivables that were due within 12 months. So it has liabilities totalling HK$19.3m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Hop Fung Group Holdings has a market capitalization of HK$77.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hop Fung Group 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 Hop Fung Group Holdings had a loss before interest and tax, and actually shrunk its revenue by 48%, to HK$587m. To be frank that doesn't bode well.

So How Risky Is Hop Fung Group Holdings?

While Hop Fung Group Holdings lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow HK$124m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too 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. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Hop Fung Group Holdings you should know about.

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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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.