CLP Holdings (HKG:2) Takes On Some Risk With Its Use Of 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, CLP Holdings Limited (HKG:2) does carry debt. But should shareholders be worried about its use of debt?

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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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is CLP Holdings's Debt?

As you can see below, at the end of December 2024, CLP Holdings had HK$65.5b of debt, up from HK$58.1b a year ago. Click the image for more detail. On the flip side, it has HK$7.91b in cash leading to net debt of about HK$57.6b.

How Healthy Is CLP Holdings' Balance Sheet?

We can see from the most recent balance sheet that CLP Holdings had liabilities of HK$44.8b falling due within a year, and liabilities of HK$78.8b due beyond that. Offsetting these obligations, it had cash of HK$7.91b as well as receivables valued at HK$12.2b due within 12 months. So it has liabilities totalling HK$103.4b more than its cash and near-term receivables, combined.

This is a mountain of leverage even relative to its gargantuan market capitalization of HK$167.4b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

Check out our latest analysis for CLP Holdings

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

CLP Holdings's net debt of 2.4 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.7 times interest expense) certainly does not do anything to dispel this impression. Notably CLP Holdings's EBIT was pretty flat over the last year. We would prefer to see some earnings growth, because that always helps diminish debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CLP Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. In the last three years, CLP Holdings's free cash flow amounted to 41% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Neither CLP Holdings's ability to handle its total liabilities nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But it seems to be able to cover its interest expense with its EBIT without much trouble. It's also worth noting that CLP Holdings is in the Electric Utilities industry, which is often considered to be quite defensive. Looking at all the angles mentioned above, it does seem to us that CLP Holdings is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for CLP Holdings you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.