Hongkong Chinese (HKG:655) Is Carrying A Fair Bit Of Debt

Warren Buffett famously said, '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. We note that Hongkong Chinese Limited (HKG:655) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hongkong Chinese

What Is Hongkong Chinese's Debt?

You can click the graphic below for the historical numbers, but it shows that Hongkong Chinese had HK$275.4m of debt in December 2020, down from HK$491.7m, one year before. However, it also had HK$209.6m in cash, and so its net debt is HK$65.8m.

How Strong Is Hongkong Chinese's Balance Sheet?

The latest balance sheet data shows that Hongkong Chinese had liabilities of HK$253.0m due within a year, and liabilities of HK$148.1m falling due after that. Offsetting this, it had HK$209.6m in cash and HK$13.3m in receivables that were due within 12 months. So it has liabilities totalling HK$178.1m more than its cash and near-term receivables, combined.

Since publicly traded Hongkong Chinese shares are worth a total of HK$1.34b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hongkong Chinese'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.

Over 12 months, Hongkong Chinese reported revenue of HK$100m, which is a gain of 42%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though Hongkong Chinese managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost HK$3.9m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through HK$31m of cash over the last year. So suffice it to say we do consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Hongkong Chinese is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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