Is Applied Development Holdings (HKG:519) Using Debt Sensibly?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 can see that Applied Development Holdings Limited (HKG:519) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Applied Development Holdings

What Is Applied Development Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Applied Development Holdings had debt of HK$240.3m at the end of December 2022, a reduction from HK$279.3m over a year. However, it does have HK$207.1m in cash offsetting this, leading to net debt of about HK$33.2m.

How Strong Is Applied Development Holdings' Balance Sheet?

According to the last reported balance sheet, Applied Development Holdings had liabilities of HK$364.8m due within 12 months, and liabilities of HK$97.1m due beyond 12 months. Offsetting this, it had HK$207.1m in cash and HK$32.5m in receivables that were due within 12 months. So its liabilities total HK$222.3m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's HK$162.8m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Applied 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.

Given it has no significant operating revenue at the moment, shareholders will be hoping Applied Development Holdings can make progress and gain better traction for the business, before it runs low on cash.

Caveat Emptor

Over the last twelve months Applied Development Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost HK$10m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through HK$53m in negative free cash flow over the last year. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Applied Development Holdings (1 makes us a bit uncomfortable) you should be aware of.

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.