David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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. As with many other companies HongDa Financial Holding Limited (HKG:1822) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is HongDa Financial Holding's Debt?
As you can see below, HongDa Financial Holding had HK$1.02b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it does have HK$27.5m in cash offsetting this, leading to net debt of about HK$996.4m.
How Strong Is HongDa Financial Holding's Balance Sheet?
According to the last reported balance sheet, HongDa Financial Holding had liabilities of HK$659.3m due within 12 months, and liabilities of HK$539.9m due beyond 12 months. Offsetting this, it had HK$27.5m in cash and HK$677.7m in receivables that were due within 12 months. So it has liabilities totalling HK$494.0m more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the HK$129.4m 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'd watch its balance sheet closely, without a doubt After all, HongDa Financial Holding would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since HongDa Financial Holding 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.
Over 12 months, HongDa Financial Holding made a loss at the EBIT level, and saw its revenue drop to HK$659m, which is a fall of 77%. That makes us nervous, to say the least.
Not only did HongDa Financial Holding's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable HK$395m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of HK$424m in the last year. So we think this stock is quite risky, like eating chicken you think might look too pink. We'd prefer pass. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how HongDa Financial Holding's profit, revenue, and operating cashflow have changed over the last few years.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.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. Thank you for reading.