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. We can see that Kerry Properties Limited (HKG:683) does use debt in its business. But should shareholders be worried about its use of debt?
Our free stock report includes 3 warning signs investors should be aware of before investing in Kerry Properties. Read for free now.Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Kerry Properties Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2024 Kerry Properties had HK$61.8b of debt, an increase on HK$57.8b, over one year. However, it also had HK$11.0b in cash, and so its net debt is HK$50.9b.
How Strong Is Kerry Properties' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Kerry Properties had liabilities of HK$22.4b due within 12 months and liabilities of HK$62.3b due beyond that. On the other hand, it had cash of HK$11.0b and HK$2.67b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$71.0b.
The deficiency here weighs heavily on the HK$25.6b 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. At the end of the day, Kerry Properties would probably need a major re-capitalization if its creditors were to demand repayment.
Check out our latest analysis for Kerry Properties
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
As it happens Kerry Properties has a fairly concerning net debt to EBITDA ratio of 11.0 but very strong interest coverage of 11.4. So either it has access to very cheap long term debt or that interest expense is going to grow! The bad news is that Kerry Properties saw its EBIT decline by 17% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kerry Properties's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Kerry Properties recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Our View
On the face of it, Kerry Properties's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. After considering the datapoints discussed, we think Kerry Properties has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Kerry Properties has 3 warning signs (and 1 which can't be ignored) we think you should know about.
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.