Pacific Century Premium Developments (HKG:432) Has Debt But No Earnings; Should You Worry?

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.' 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. As with many other companies Pacific Century Premium Developments Limited (HKG:432) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Pacific Century Premium Developments

What Is Pacific Century Premium Developments's Debt?

The image below, which you can click on for greater detail, shows that Pacific Century Premium Developments had debt of HK$8.97b at the end of December 2022, a reduction from HK$11.3b over a year. However, it also had HK$686.0m in cash, and so its net debt is HK$8.29b.

How Healthy Is Pacific Century Premium Developments' Balance Sheet?

The latest balance sheet data shows that Pacific Century Premium Developments had liabilities of HK$1.50b due within a year, and liabilities of HK$8.58b falling due after that. On the other hand, it had cash of HK$686.0m and HK$82.0m worth of receivables due within a year. So its liabilities total HK$9.31b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$723.6m 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.

Over 12 months, Pacific Century Premium Developments reported revenue of HK$561m, which is a gain of 20%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though Pacific Century Premium Developments managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost a very considerable HK$331m at the EBIT level. 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 lost HK$598m in the last year. So we're not very excited about owning this stock. Its too risky for us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Pacific Century Premium Developments (including 1 which is a bit unpleasant) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.