Is Applied Development Holdings (HKG:519) Using Debt In A Risky Way?

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 Applied Development Holdings Limited (HKG:519) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Applied Development Holdings

What Is Applied Development Holdings's Debt?

As you can see below, Applied Development Holdings had HK$271.9m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds HK$594.8m in cash, so it actually has HK$323.0m net cash.

How Healthy Is Applied Development Holdings' Balance Sheet?

We can see from the most recent balance sheet that Applied Development Holdings had liabilities of HK$565.7m falling due within a year, and liabilities of HK$84.2m due beyond that. On the other hand, it had cash of HK$594.8m and HK$925.0k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$54.1m.

Of course, Applied Development Holdings has a market capitalization of HK$410.8m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Applied Development Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Applied 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.

Given it has no significant operating revenue at the moment, shareholders will be hoping Applied Development Holdings can make progress and gain better traction for the business, before it runs low on cash.

So How Risky Is Applied Development Holdings?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Applied Development Holdings had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of HK$27m and booked a HK$174m accounting loss. With only HK$323.0m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Applied Development Holdings has 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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.

When trading Applied Development Holdings or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.