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 Hop Fung Group Holdings Limited (HKG:2320) resorts to debt. But should shareholders worry about its use of debt?
Why is debt risky?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
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How much debt does Hop Fung Group Holdings have?
The image below, which you can click on for more details, shows that Hop Fung Group Holdings had debt of HK$145.6 million at the end of June 2022, a reduction from HK$263.0 million over a year. But on the other hand, he also has HK$200.8 million in cash, resulting in a net cash position of HK$55.1 million.
How healthy is Hop Fung Group Holdings’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Hop Fung Group Holdings had liabilities of HK$193.8 million due within 12 months and liabilities of HK$110.7 million due beyond. In return, he had HK$200.8 million in cash and HK$84.3 million in debt due within 12 months. It therefore has liabilities totaling HK$19.3 million more than its cash and short-term receivables, combined.
While that might sound like a lot, it’s not that bad since Hop Fung Group Holdings has a market capitalization of HK$77.7 million, so it could likely bolster its balance sheet by raising capital if needed. However, it is always worth taking a close look at its ability to repay debt. Despite its notable liabilities, Hop Fung Group Holdings has net cash, so it’s fair to say that it doesn’t have heavy debt! There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since Hop Fung Group Holdings will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Last year, Hop Fung Group Holdings posted a loss before interest and tax and actually reduced its revenue by 48% to HK$587 million. To be honest, that doesn’t bode well.
So how risky is Hop Fung Group Holdings?
While Hop Fung Group Holdings lost money in earnings before interest and tax (EBIT), it actually generated positive free cash flow of HK$124 million. So taking that at face value and given the net cash position, we don’t think the stock is too risky in the near term. Until we see a positive EBIT, we are a bit cautious on the stock, especially given the rather modest revenue growth. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Hop Fung Group Holdings you should know.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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Find out if Hop Fung Group Farms is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.
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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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