We Think Henderson Land Development (HKG:12) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Henderson Land Development Company Limited (HKG:12) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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?

The chart below, which you can click on for greater detail, shows that Henderson Land Development had HK$102.3b in debt in June 2021; about the same as the year before. However, it does have HK$14.4b in cash offsetting this, leading to net debt of about HK$87.9b.

How Healthy Is Henderson Land Development's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Henderson Land Development had liabilities of HK$51.5b due within 12 months and liabilities of HK$90.6b due beyond that. Offsetting these obligations, it had cash of HK$14.4b as well as receivables valued at HK$19.9b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$107.7b.

This is a mountain of leverage even relative to its gargantuan market capitalization of HK$160.0b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

Strangely Henderson Land Development has a sky high EBITDA ratio of 7.8, implying high debt, but a strong interest coverage of 136. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Unfortunately, Henderson Land Development saw its EBIT slide 5.3% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Henderson Land Development's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Henderson Land Development actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Based on what we've seen Henderson Land Development is not finding it easy, given its net debt to EBITDA, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Henderson Land Development's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Henderson Land Development's dividend history, without delay!

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.

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.

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