These 4 metrics indicate that Hysan Development (HKG:14) makes extensive use of debt

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies Hysan Development Company Limited (HKG:14) uses debt. But the more important question is: what risk does this debt create?

When is debt a problem?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, many companies use debt to finance their growth, without any negative consequences. When we look at debt levels, we first consider cash and debt levels, together.

Check out our latest analysis for Hysan Development

What is Hysan Development’s debt?

As you can see below, at the end of December 2021, Hysan Development had a debt of HK$26.6 billion, compared to HK$19.2 billion a year ago. Click on the image for more details. On the other hand, it has HK$6.54 billion in cash, resulting in a net debt of around HK$20.0 billion.

SEHK: 14 Historical Debt to Equity April 27, 2022

How healthy is Hysan Development’s balance sheet?

According to the latest published balance sheet, Hysan Development had liabilities of HK$1.94 billion due within 12 months and liabilities of HK$27.6 billion due beyond 12 months. In return, it had HK$6.54 billion in cash and HK$926.0 million in receivables due within 12 months. It therefore has liabilities totaling HK$22.0 billion more than its cash and short-term receivables, combined.

That’s a mountain of leverage compared to its market capitalization of HK$23.7 billion. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Strangely, Hysan Development has an exorbitant EBITDA ratio of 6.4, implying high debt, but high interest coverage of 12.2. Either he has access to very cheap long-term debt, or his interest costs will increase! Unfortunately, Hysan Development has seen its EBIT drop by 2.2% over the last twelve months. If profits continue to fall, managing that debt will be as difficult as delivering hot soup on a unicycle. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hysan Development’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a company can only repay its debts with cold hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Hysan Development has produced strong free cash flow equivalent to 80% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.

Our point of view

While Hysan Development’s net debt to EBITDA makes us nervous. For example, its interest coverage and conversion of EBIT to free cash flow gives us some confidence in its ability to manage its debt. We think Hysan Development’s debt makes it a bit risky, after looking at the aforementioned data points together. This isn’t necessarily a bad thing, as leverage can increase return on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example – Hysan Development has 1 warning sign we think you should know.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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John A. Bogar