Stock Analysis

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

SEHK:519
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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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Applied Development Holdings Limited (HKG:519) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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 Applied Development Holdings

How Much Debt Does Applied Development Holdings Carry?

As you can see below, Applied Development Holdings had HK$279.3m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. But it also has HK$459.6m in cash to offset that, meaning it has HK$180.3m net cash.

debt-equity-history-analysis
SEHK:519 Debt to Equity History March 2nd 2022

How Strong Is Applied Development Holdings' Balance Sheet?

The latest balance sheet data shows that Applied Development Holdings had liabilities of HK$523.8m due within a year, and liabilities of HK$101.5m falling due after that. Offsetting these obligations, it had cash of HK$459.6m as well as receivables valued at HK$11.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$154.4m.

While this might seem like a lot, it is not so bad since Applied Development Holdings has a market capitalization of HK$268.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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. There's no doubt that we learn most about debt from the balance sheet. But it is Applied Development Holdings's earnings that will influence how the balance sheet holds up in the future. 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 in the last year Applied Development Holdings had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of HK$92m and booked a HK$76m accounting loss. With only HK$180.3m on the balance sheet, it would appear that its going to need to raise capital again soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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. To that end, you should learn about the 3 warning signs we've spotted with Applied Development Holdings (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.