Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Macau Legend Development Limited (HKG:1680) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Macau Legend Development
How Much Debt Does Macau Legend Development Carry?
As you can see below, Macau Legend Development had HK$2.41b of debt at June 2024, down from HK$2.61b a year prior. However, it does have HK$81.6m in cash offsetting this, leading to net debt of about HK$2.33b.
How Strong Is Macau Legend Development's Balance Sheet?
According to the last reported balance sheet, Macau Legend Development had liabilities of HK$2.67b due within 12 months, and liabilities of HK$209.6m due beyond 12 months. Offsetting this, it had HK$81.6m in cash and HK$82.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$2.72b.
The deficiency here weighs heavily on the HK$613.9m 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, Macau Legend Development 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 Macau Legend Development 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.
Over 12 months, Macau Legend Development reported revenue of HK$957m, which is a gain of 63%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.
Caveat Emptor
Even though Macau Legend Development managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping HK$158m. 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 on the bright side the company actually produced a statutory profit of HK$23m and free cash flow of HK$166m. So one might argue that there's still a chance it can get things on the right track. 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. Case in point: We've spotted 3 warning signs for Macau Legend Development you should be aware of, and 1 of them shouldn't be ignored.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.