Is Pacific Century Premium Developments (HKG:432) Using Debt In A Risky Way?

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 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. Importantly, Pacific Century Premium Developments Limited (HKG:432) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that 432 is potentially overvalued!

What Is Pacific Century Premium Developments's Debt?

You can click the graphic below for the historical numbers, but it shows that Pacific Century Premium Developments had HK$8.86b of debt in June 2022, down from HK$11.3b, one year before. However, it also had HK$911.0m in cash, and so its net debt is HK$7.95b.

A Look At Pacific Century Premium Developments' Liabilities

According to the last reported balance sheet, Pacific Century Premium Developments had liabilities of HK$1.40b due within 12 months, and liabilities of HK$8.50b due beyond 12 months. On the other hand, it had cash of HK$911.0m and HK$17.0m worth of receivables due within a year. So its liabilities total HK$8.97b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$672.6m 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. At the end of the day, Pacific Century Premium Developments would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Pacific Century Premium Developments'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.

In the last year Pacific Century Premium Developments wasn't profitable at an EBIT level, but managed to grow its revenue by 16%, to HK$526m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Pacific Century Premium Developments produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping HK$380m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it burned through HK$171m in the last year. So we consider this a high risk stock, and we're worried its share price could sink faster than than a dingy with a great white shark attacking it. 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. To that end, you should learn about the 2 warning signs we've spotted with Pacific Century Premium Developments (including 1 which shouldn't be ignored) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.