We Think Harbour Centre Development (HKG:51) Can Stay On Top Of Its Debt

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. 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. We can see that Harbour Centre Development Limited (HKG:51) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Harbour Centre Development

What Is Harbour Centre Development's Net Debt?

The chart below, which you can click on for greater detail, shows that Harbour Centre Development had HK$2.58b in debt in June 2019; about the same as the year before. But it also has HK$3.18b in cash to offset that, meaning it has HK$598.0m net cash.

SEHK:51 Historical Debt, October 10th 2019
SEHK:51 Historical Debt, October 10th 2019

How Strong Is Harbour Centre Development's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Harbour Centre Development had liabilities of HK$6.80b due within 12 months and liabilities of HK$2.77b due beyond that. Offsetting this, it had HK$3.18b in cash and HK$372.0m in receivables that were due within 12 months. So it has liabilities totalling HK$6.02b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of HK$9.22b, so it does suggest shareholders should keep an eye on Harbour Centre Development's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Harbour Centre Development boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Harbour Centre Development's saving grace is its low debt levels, because its EBIT has tanked 82% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Harbour Centre Development's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Harbour Centre Development may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Harbour Centre Development produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While Harbour Centre Development does have more liabilities than liquid assets, it also has net cash of HK$598.0m. And it impressed us with free cash flow of HK$2.2b, being 71% of its EBIT. So we are not troubled with Harbour Centre Development's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Harbour Centre Development's earnings per share history for free.

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 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. Thank you for reading.