Health Check: How Prudently Does Hopson Development Holdings (HKG:754) Use Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Hopson Development Holdings Limited (HKG:754) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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.

View our latest analysis for Hopson Development Holdings

What Is Hopson Development Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Hopson Development Holdings had debt of HK$107.1b at the end of June 2022, a reduction from HK$129.4b over a year. However, it does have HK$26.6b in cash offsetting this, leading to net debt of about HK$80.5b.

How Healthy Is Hopson Development Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hopson Development Holdings had liabilities of HK$124.9b due within 12 months and liabilities of HK$90.6b due beyond that. Offsetting this, it had HK$26.6b in cash and HK$20.4b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$168.6b.

This deficit casts a shadow over the HK$24.8b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Hopson Development Holdings would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hopson Development Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Hopson Development Holdings made a loss at the EBIT level, and saw its revenue drop to HK$28b, which is a fall of 30%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Hopson Development Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at HK$696m. 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. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But on the bright side the company actually produced a statutory profit of HK$11b and free cash flow of HK$20b. So its situation may not be as precarious as the EBIT would imply. 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 Hopson Development Holdings has 2 warning signs (and 1 which is a bit concerning) we think you should know about.

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. 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.