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

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Applied Development Holdings Limited (HKG:519) does carry debt. But the real question is whether this debt is making the company risky.

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Applied Development Holdings

What Is Applied Development Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Applied Development Holdings had HK$210.1m of debt in June 2023, down from HK$244.2m, one year before. However, it also had HK$140.5m in cash, and so its net debt is HK$69.6m.

How Healthy Is Applied Development Holdings' Balance Sheet?

According to the last reported balance sheet, Applied Development Holdings had liabilities of HK$401.8m due within 12 months, and liabilities of HK$95.8m due beyond 12 months. On the other hand, it had cash of HK$140.5m and HK$28.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$328.8m.

The deficiency here weighs heavily on the HK$212.9m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Applied Development Holdings would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Applied Development Holdings's earnings that will influence how the balance sheet holds up in the future. 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.

It seems likely shareholders hope that Applied Development Holdings can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.

Caveat Emptor

Over the last twelve months Applied Development Holdings produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at HK$1.6m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of HK$43m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Applied Development Holdings has 3 warning signs (and 2 which are concerning) we think you should know about.

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.