Is the development of the new world (HKG:17) a risky investment?
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies New World Development Company Limited (HKG:17) uses debt. But does this debt worry shareholders?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
Discover our latest analysis for New World Development
What is New World Development Net Debt?
As you can see below, New World Development had a debt of HK$183.9 billion, as of December 2021, which is about the same as the previous year. You can click on the graph for more details. However, since it has a cash reserve of HK$57.1 billion, its net debt is lower at around HK$126.8 billion.
How strong is New World Development’s balance sheet?
We can see from the most recent balance sheet that New World Development had liabilities of HK$175.1 billion due in one year, and liabilities of HK$163.9 billion due beyond. As compensation for these obligations, it had liquid assets of HK$57.1 billion as well as receivables valued at HK$36.9 billion and due within 12 months. Thus, its liabilities total HK$245.0 billion more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the 73.2 billion Hong Kong dollar company, like a colossus towering above mere mortals. So we definitely think shareholders need to watch this one closely. Ultimately, New World Development would likely need a major recapitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Strangely, New World Development has an exorbitant EBITDA ratio of 20.5, implying high debt, but high interest coverage of 1k. Either he has access to very cheap long-term debt, or his interest costs will increase! Shareholders should know that New World Development’s EBIT fell 44% last year. If this earnings trend continues, paying off debt will be about as easy as herding cats on a roller coaster. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine New World Development’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, New World Development has experienced substantial negative free cash flow, in total. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
At first glance, New World Development’s EBIT growth rate left us hesitant about the stock, and its level of total liabilities was no more appealing than the single empty restaurant on the busiest night of the year. . But on the bright side, its interest coverage is a good sign and makes us more optimistic. Considering all the factors mentioned above, we believe that New World Development is seriously over-leveraged. For us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel otherwise. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 3 harbingers of new global development (1 is potentially serious) of which you should be aware.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.