Applied Development Holdings (HKG:519) Has Debt But No Earnings; Should You Worry?
Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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. As with many other companies Applied Development Holdings Limited (HKG:519) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. 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 Applied Development Holdings
What Is Applied Development Holdings's Debt?
You can click the graphic below for the historical numbers, but it shows that Applied Development Holdings had HK$280.5m of debt in December 2019, down from HK$479.2m, one year before. But it also has HK$657.3m in cash to offset that, meaning it has HK$376.8m net cash.
A Look At Applied Development Holdings's Liabilities
The latest balance sheet data shows that Applied Development Holdings had liabilities of HK$738.6m due within a year, and liabilities of HK$97.6m falling due after that. Offsetting these obligations, it had cash of HK$657.3m as well as receivables valued at HK$57.7m due within 12 months. So its liabilities total HK$121.2m more than the combination of its cash and short-term receivables.
Applied Development Holdings has a market capitalization of HK$468.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Applied Development Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Applied Development Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
It seems likely shareholders hope that Applied Development Holdings can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.
So How Risky Is Applied Development Holdings?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Applied Development Holdings had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through HK$5.8m of cash and made a loss of HK$221m. With only HK$376.8m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Applied Development Holdings (1 shouldn't be ignored) you should be aware of.
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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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