Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Hutchison Port Holdings Trust (SGX:NS8U) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

Check out our latest analysis for Hutchison Port Holdings Trust

How Much Debt Does Hutchison Port Holdings Trust Carry?

The image below, which you can click on for greater detail, shows that Hutchison Port Holdings Trust had debt of HK$25.9b at the end of June 2023, a reduction from HK$27.3b over a year. However, because it has a cash reserve of HK$7.15b, its net debt is less, at about HK$18.8b.

A Look At Hutchison Port Holdings Trust's Liabilities

We can see from the most recent balance sheet that Hutchison Port Holdings Trust had liabilities of HK$7.34b falling due within a year, and liabilities of HK$33.4b due beyond that. Offsetting these obligations, it had cash of HK$7.15b as well as receivables valued at HK$2.63b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$31.0b.

This deficit casts a shadow over the HK$10.7b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Hutchison Port Holdings Trust would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Hutchison Port Holdings Trust has a debt to EBITDA ratio of 3.7 and its EBIT covered its interest expense 4.7 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly, Hutchison Port Holdings Trust's EBIT fell a jaw-dropping 35% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hutchison Port Holdings Trust'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Hutchison Port Holdings Trust actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, Hutchison Port Holdings Trust's EBIT growth rate 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 converting EBIT to free cash flow; that's encouraging. It's also worth noting that Hutchison Port Holdings Trust is in the Infrastructure industry, which is often considered to be quite defensive. Overall, it seems to us that Hutchison Port Holdings Trust's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. To that end, you should learn about the 3 warning signs we've spotted with Hutchison Port Holdings Trust (including 1 which is a bit concerning) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.