Here’s Why Hang Lung Properties (HKG: 101) Can Responsibly Manage Debt
David Iben put it well when he said, âVolatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ It is only natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. We can see that Hang Lung Properties Limited (HKG: 101) uses debt in his business. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
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How much debt do Hang Lung properties carry?
You can click on the graph below for historical figures, but it shows that as of June 2021, Hang Lung Properties had a debt of HK $ 41.7 billion, an increase from HK 33.2 billion. $, over one year. However, he also had HK $ 2.92 billion in cash, so his net debt is HK $ 38.7 billion.
A look at the responsibilities of Hang Lung Properties
According to the latest published balance sheet, Hang Lung Properties had a liability of HK $ 18.9 billion due within 12 months and a liability of HK $ 46.7 billion due beyond 12 months. In compensation for these obligations, he had cash of HK $ 2.92 billion as well as receivables valued at HK $ 2.77 billion due within 12 months. Its liabilities therefore total HK $ 59.9 billion more than the combination of its cash and short-term receivables.
This shortfall is sizable compared to its market cap of HK $ 69.9 billion, so he suggests shareholders keep an eye on Hang Lung Properties’ use of debt. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution.
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
As it turns out, Hang Lung Properties has a rather worrying net debt to EBITDA ratio of 5.9 but very strong interest coverage of 30.7. This means that unless the business has access to very cheap debt, these interest charges will likely increase in the future. One way Hang Lung Properties could beat its debt would be to stop borrowing more but continue to increase its EBIT by around 15%, like it did last year. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Hang Lung Properties can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Hang Lung Properties has recorded free cash flow of 62% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
Based on our analysis, Hang Lung Properties’ interest coverage should indicate that it will not have too many problems with its debt. However, our other observations were not so encouraging. To be precise, it seems about as good at managing debt, based on its EBITDA, as wet socks are at keeping feet warm. When we consider all of the factors mentioned above, we feel a little cautious about Hang Lung Properties’ use of debt. While debt has its advantage in potential higher returns, we believe shareholders should definitely consider how leverage levels might make the stock riskier. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example – Hang Lung Properties has 2 warning signs we think you should be aware.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.