David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies CLP Holdings Limited (HKG:2) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for CLP Holdings
How Much Debt Does CLP Holdings Carry?
The image below, which you can click on for greater detail, shows that at June 2022 CLP Holdings had debt of HK$65.0b, up from HK$59.1b in one year. However, it also had HK$12.8b in cash, and so its net debt is HK$52.2b.SEHK:2 Debt to Equity History September 2nd 2022
How Strong Is CLP Holdings' Balance Sheet?
According to the last reported balance sheet, CLP Holdings had liabilities of HK$64.3b due within 12 months, and liabilities of HK$76.1b due beyond 12 months. Offsetting these obligations, it had cash of HK$12.8b as well as receivables valued at HK$17.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$110.0b.
This is a mountain of leverage even relative to its gargantuan market capitalization of HK$166.6b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. 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 CLP Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, CLP Holdings reported revenue of HK$91b, which is a gain of 11%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months CLP Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost HK$1.4b at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled HK$5.7b in negative free cash flow over the last twelve months. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - CLP Holdings has 2 warning signs we think you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.