These 4 Measures Indicate That HKR International (HKG:480) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 HKR International Limited (HKG:480) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for HKR International

What Is HKR International's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 HKR International had debt of HK$8.17b, up from HK$7.58b in one year. However, it does have HK$3.35b in cash offsetting this, leading to net debt of about HK$4.82b.

How Healthy Is HKR International's Balance Sheet?

According to the last reported balance sheet, HKR International had liabilities of HK$3.80b due within 12 months, and liabilities of HK$7.07b due beyond 12 months. On the other hand, it had cash of HK$3.35b and HK$232.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$7.29b.

When you consider that this deficiency exceeds the company's HK$5.05b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

HKR International has a debt to EBITDA ratio of 2.6, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 12.2 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Pleasingly, HKR International is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 112% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine HKR International'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, HKR International recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

While HKR International's level of total liabilities has us nervous. To wit both its interest cover and EBIT growth rate were encouraging signs. Looking at all the angles mentioned above, it does seem to us that HKR International is a somewhat risky investment as a result of its debt. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example HKR International has 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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