Does Hutchison Port Holdings Trust (SGX:NS8U) Have A Healthy Balance Sheet?

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. Importantly, Hutchison Port Holdings Trust (SGX:NS8U) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hutchison Port Holdings Trust

What Is Hutchison Port Holdings Trust's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Hutchison Port Holdings Trust had HK$27.2b of debt in December 2022, down from HK$29.2b, one year before. However, because it has a cash reserve of HK$10.4b, its net debt is less, at about HK$16.8b.

How Healthy Is Hutchison Port Holdings Trust's Balance Sheet?

We can see from the most recent balance sheet that Hutchison Port Holdings Trust had liabilities of HK$11.4b falling due within a year, and liabilities of HK$31.0b due beyond that. On the other hand, it had cash of HK$10.4b and HK$3.12b worth of receivables due within a year. So it has liabilities totalling HK$28.9b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the HK$12.6b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Hutchison Port Holdings Trust would probably need a major re-capitalization if its creditors were to demand repayment.

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).

Hutchison Port Holdings Trust has a debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 7.0 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The bad news is that Hutchison Port Holdings Trust saw its EBIT decline by 20% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hutchison Port Holdings Trust's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Hutchison Port Holdings Trust actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, Hutchison Port Holdings Trust's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We should also note that Infrastructure industry companies like Hutchison Port Holdings Trust commonly do use debt without problems. Looking at the bigger picture, it seems clear to us that Hutchison Port Holdings Trust's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Hutchison Port Holdings Trust is showing 2 warning signs in our investment analysis , 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.