Is Infinity Development Holdings (HKG:640) 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.' 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 can see that Infinity Development Holdings Company Limited (HKG:640) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Infinity Development Holdings

What Is Infinity Development Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Infinity Development Holdings had debt of HK$33.9m, up from none in one year. However, its balance sheet shows it holds HK$179.1m in cash, so it actually has HK$145.2m net cash.

A Look At Infinity Development Holdings' Liabilities

We can see from the most recent balance sheet that Infinity Development Holdings had liabilities of HK$153.9m falling due within a year, and liabilities of HK$15.5m due beyond that. Offsetting these obligations, it had cash of HK$179.1m as well as receivables valued at HK$166.1m due within 12 months. So it can boast HK$175.8m more liquid assets than total liabilities.

This surplus strongly suggests that Infinity Development Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Infinity Development Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Infinity Development Holdings has increased its EBIT by 3.6% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Infinity Development 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Infinity Development Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Infinity Development Holdings recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Infinity Development Holdings has net cash of HK$145.2m, as well as more liquid assets than liabilities. And it also grew its EBIT by 3.6% over the last year. So we don't think Infinity Development Holdings's use of debt is risky. 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 Infinity Development Holdings is showing 2 warning signs in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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.
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