Sun Hung Kai Properties (HKG:16) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Sun Hung Kai Properties Limited (HKG:16) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sun Hung Kai Properties

What Is Sun Hung Kai Properties's Debt?

As you can see below, Sun Hung Kai Properties had HK$127.1b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has HK$16.9b in cash leading to net debt of about HK$110.2b.

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$62.0b falling due within a year, and liabilities of HK$145.0b due beyond that. Offsetting this, it had HK$16.9b in cash and HK$17.1b in receivables that were due within 12 months. So it has liabilities totalling HK$173.0b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its very significant market capitalization of HK$245.8b, so it does suggest shareholders should keep an eye on Sun Hung Kai Properties' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt to EBITDA of 4.0 Sun Hung Kai Properties has a fairly noticeable amount of debt. But the high interest coverage of 7.4 suggests it can easily service that debt. Unfortunately, Sun Hung Kai Properties saw its EBIT slide 7.8% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Sun Hung Kai Properties's free cash flow amounted to 39% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

At the end of the day, we're far from enamoured with Sun Hung Kai Properties's ability handle its debt, based on its EBITDA, or to grow its EBIT. But the silver lining is its relatively strong interest cover. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Sun Hung Kai Properties stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. We've identified 1 warning sign with Sun Hung Kai Properties , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.