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 Hung Fook Tong Group Holdings Limited (HKG:1446) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Hung Fook Tong Group Holdings's Debt?
The image below, which you can click on for greater detail, shows that at December 2024 Hung Fook Tong Group Holdings had debt of HK$38.8m, up from HK$36.6m in one year. But on the other hand it also has HK$110.2m in cash, leading to a HK$71.5m net cash position.
How Strong Is Hung Fook Tong Group Holdings' Balance Sheet?
We can see from the most recent balance sheet that Hung Fook Tong Group Holdings had liabilities of HK$360.5m falling due within a year, and liabilities of HK$74.5m due beyond that. Offsetting this, it had HK$110.2m in cash and HK$67.9m in receivables that were due within 12 months. So its liabilities total HK$256.9m more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of HK$219.7m, we think shareholders really should watch Hung Fook Tong Group Holdings's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Given that Hung Fook Tong Group Holdings has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hung Fook Tong Group Holdings 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.
Check out our latest analysis for Hung Fook Tong Group Holdings
Over 12 months, Hung Fook Tong Group Holdings made a loss at the EBIT level, and saw its revenue drop to HK$621m, which is a fall of 7.7%. That's not what we would hope to see.
So How Risky Is Hung Fook Tong Group Holdings?
Although Hung Fook Tong Group Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of HK$125m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Hung Fook Tong Group Holdings (of which 1 is significant!) you should know about.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.