Here's Why Henderson Land Development (HKG:12) Has A Meaningful Debt Burden

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Henderson Land Development Company Limited (HKG:12) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Henderson Land Development

How Much Debt Does Henderson Land Development Carry?

As you can see below, at the end of June 2020, Henderson Land Development had HK$102.7b of debt, up from HK$92.7b a year ago. Click the image for more detail. On the flip side, it has HK$11.1b in cash leading to net debt of about HK$91.6b.

How Strong Is Henderson Land Development's Balance Sheet?

The latest balance sheet data shows that Henderson Land Development had liabilities of HK$58.1b due within a year, and liabilities of HK$76.5b falling due after that. Offsetting these obligations, it had cash of HK$11.1b as well as receivables valued at HK$18.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$105.0b.

This deficit is considerable relative to its very significant market capitalization of HK$144.3b, so it does suggest shareholders should keep an eye on Henderson Land Development's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

As it happens Henderson Land Development has a fairly concerning net debt to EBITDA ratio of 7.7 but very strong interest coverage of 26.9. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Importantly, Henderson Land Development grew its EBIT by 67% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Henderson Land Development can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Henderson Land Development created free cash flow amounting to 5.6% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

We feel some trepidation about Henderson Land Development's difficulty net debt to EBITDA, but we've got positives to focus on, too. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. We think that Henderson Land Development's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For instance, we've identified 2 warning signs for Henderson Land Development that you should be aware of.

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. 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.
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