Is Pacific Century Premium Developments (HKG:432) Using Debt In A Risky Way?

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 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. Importantly, Pacific Century Premium Developments Limited (HKG:432) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Pacific Century Premium Developments

How Much Debt Does Pacific Century Premium Developments Carry?

The image below, which you can click on for greater detail, shows that at December 2023 Pacific Century Premium Developments had debt of HK$9.44b, up from HK$8.97b in one year. However, because it has a cash reserve of HK$865.0m, its net debt is less, at about HK$8.58b.

How Healthy Is Pacific Century Premium Developments' Balance Sheet?

According to the last reported balance sheet, Pacific Century Premium Developments had liabilities of HK$1.17b due within 12 months, and liabilities of HK$9.17b due beyond 12 months. Offsetting these obligations, it had cash of HK$865.0m as well as receivables valued at HK$101.0m due within 12 months. So it has liabilities totalling HK$9.38b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$413.8m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Pacific Century Premium Developments would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is Pacific Century Premium Developments's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Pacific Century Premium Developments wasn't profitable at an EBIT level, but managed to grow its revenue by 47%, to HK$822m. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Despite the top line growth, Pacific Century Premium Developments still had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$89m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it burned through HK$97m in the last year. So is this a high risk stock? We think so, and we'd avoid it. 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. Be aware that Pacific Century Premium Developments is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.