Is Sun Hung Kai Properties (HKG:16) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that Sun Hung Kai Properties Limited (HKG:16) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Sun Hung Kai Properties

What Is Sun Hung Kai Properties's Net Debt?

The chart below, which you can click on for greater detail, shows that Sun Hung Kai Properties had HK$135.7b in debt in December 2023; about the same as the year before. On the flip side, it has HK$8.61b in cash leading to net debt of about HK$127.1b.

A Look At Sun Hung Kai Properties' Liabilities

We can see from the most recent balance sheet that Sun Hung Kai Properties had liabilities of HK$65.1b falling due within a year, and liabilities of HK$144.2b due beyond that. On the other hand, it had cash of HK$8.61b and HK$15.2b worth of receivables due within a year. So its liabilities total HK$185.5b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its very significant market capitalization of HK$216.3b, so it does suggest shareholders should keep an eye on Sun Hung Kai Properties' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Sun Hung Kai Properties has net debt to EBITDA of 4.2 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 9.5 times its interest expense, and its net debt to EBITDA, was quite high, at 4.2. Sun Hung Kai Properties grew its EBIT by 2.7% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sun Hung Kai Properties's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Sun Hung Kai Properties recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Neither Sun Hung Kai Properties's ability handle its debt, based on its EBITDA, nor its level of total liabilities gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Sun Hung Kai Properties's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Sun Hung Kai Properties that you should be aware of before investing here.

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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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.