Stock Analysis

Hopson Development Holdings (HKG:754) Has A Somewhat Strained Balance Sheet

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SEHK:754
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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 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. As with many other companies Hopson Development Holdings Limited (HKG:754) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Hopson Development Holdings

What Is Hopson Development Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Hopson Development Holdings had HK$93.8b of debt in June 2023, down from HK$107.1b, one year before. On the flip side, it has HK$20.2b in cash leading to net debt of about HK$73.6b.

debt-equity-history-analysis
SEHK:754 Debt to Equity History December 11th 2023

How Strong Is Hopson Development Holdings' Balance Sheet?

The latest balance sheet data shows that Hopson Development Holdings had liabilities of HK$117.5b due within a year, and liabilities of HK$79.2b falling due after that. On the other hand, it had cash of HK$20.2b and HK$12.6b worth of receivables due within a year. So its liabilities total HK$163.8b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$15.3b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Hopson Development Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Hopson Development Holdings has a rather high debt to EBITDA ratio of 11.7 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 7.0 times, suggesting it can responsibly service its obligations. Notably, Hopson Development Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of HK$6.0b in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hopson Development Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Hopson Development Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, Hopson Development Holdings's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Hopson Development Holdings's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. We've identified 3 warning signs with Hopson Development Holdings , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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