Is Hop Fung Group Holdings (HKG:2320) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Hop Fung Group Holdings Limited (HKG:2320) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hop Fung Group Holdings

How Much Debt Does Hop Fung Group Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Hop Fung Group Holdings had HK$328.2m of debt, an increase on HK$208.4m, over one year. However, it does have HK$373.8m in cash offsetting this, leading to net cash of HK$45.6m.

How Strong Is Hop Fung Group Holdings's Balance Sheet?

We can see from the most recent balance sheet that Hop Fung Group Holdings had liabilities of HK$321.4m falling due within a year, and liabilities of HK$225.5m due beyond that. Offsetting this, it had HK$373.8m in cash and HK$106.0m in receivables that were due within 12 months. So it has liabilities totalling HK$67.1m 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$184.0m, 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. While it does have liabilities worth noting, Hop Fung Group Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely. 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.

Over 12 months, Hop Fung Group Holdings made a loss at the EBIT level, and saw its revenue drop to HK$922m, which is a fall of 33%. To be frank that doesn't bode well.

So How Risky Is Hop Fung Group Holdings?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Hop Fung Group Holdings had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of HK$65m and booked a HK$37m accounting loss. With only HK$45.6m on the balance sheet, it would appear that its going to need to raise capital again soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Hop Fung Group Holdings has 2 warning signs (and 1 which is concerning) we think 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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