HCK Capital Group Berhad (KLSE:HCK) Seems To Be Using A Lot Of Debt

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 HCK Capital Group Berhad (KLSE:HCK) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for HCK Capital Group Berhad

How Much Debt Does HCK Capital Group Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 HCK Capital Group Berhad had RM303.0m of debt, an increase on RM226.4m, over one year. However, it also had RM10.7m in cash, and so its net debt is RM292.3m.

How Healthy Is HCK Capital Group Berhad's Balance Sheet?

The latest balance sheet data shows that HCK Capital Group Berhad had liabilities of RM240.8m due within a year, and liabilities of RM310.5m falling due after that. Offsetting this, it had RM10.7m in cash and RM158.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM382.3m.

HCK Capital Group Berhad has a market capitalization of RM738.2m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

HCK Capital Group Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (22.4), and fairly weak interest coverage, since EBIT is just 1.9 times the interest expense. The debt burden here is substantial. Worse, HCK Capital Group Berhad's EBIT was down 30% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since HCK Capital Group Berhad will need earnings to service that debt. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, HCK Capital Group Berhad saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both HCK Capital Group Berhad's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to handle its total liabilities isn't such a worry. Taking into account all the aforementioned factors, it looks like HCK Capital Group Berhad has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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 instance, we've identified 3 warning signs for HCK Capital Group Berhad (1 is significant) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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