Is Hopson Development Holdings (HKG:754) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Hopson Development Holdings Limited (HKG:754) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Hopson Development Holdings

How Much Debt Does Hopson Development Holdings Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Hopson Development Holdings had debt of HK$123.5b, up from HK$67.1b in one year. However, it does have HK$49.9b in cash offsetting this, leading to net debt of about HK$73.6b.

How Strong Is Hopson Development Holdings' Balance Sheet?

We can see from the most recent balance sheet that Hopson Development Holdings had liabilities of HK$95.0b falling due within a year, and liabilities of HK$108.0b due beyond that. On the other hand, it had cash of HK$49.9b and HK$5.62b worth of receivables due within a year. So its liabilities total HK$147.4b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$62.3b 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Hopson Development Holdings has a debt to EBITDA ratio of 4.1, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 11.7 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, Hopson Development Holdings is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 162% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hopson 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Hopson Development Holdings recorded free cash flow of 26% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over Hopson Development Holdings's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But at least it's pretty decent at growing its EBIT; that's encouraging. Once we consider all the factors above, together, it seems to us that Hopson Development Holdings's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. For example, we've discovered 3 warning signs for Hopson Development Holdings (1 can't be ignored!) that you should be aware of before investing here.

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. 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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