Is Wharf real estate investing (HKG: 1997) a risky investment?
Legendary fund manager Li Lu (who Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Like many other companies Wharf Real Estate Investment Company Limited (HKG: 1997) uses debt. But does this debt worry shareholders?
When Is Debt a Problem?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its 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 of a business’s use of debt, we first look at cash flow and debt together.
Check out our latest review for Wharf Real Estate Investment
How much debt does Wharf real estate investment carry?
As you can see below, Wharf Real Estate Investment had HK $ 53.4 billion in debt in June 2021, up from HK $ 58.1 billion the year before. However, he also had HK $ 2.95 billion in cash, so his net debt is HK $ 50.4 billion.
How strong is Wharf Real Estate Investment’s balance sheet?
According to the latest published balance sheet, Wharf Real Estate Investment had liabilities of HK $ 11.5 billion due within 12 months and liabilities of HK $ 54.6 billion due beyond 12 months. In compensation for these obligations, he had cash of HK $ 2.95 billion as well as receivables valued at HK $ 1.25 billion due within 12 months. It therefore has liabilities totaling HK $ 61.9 billion more than its cash and short-term receivables combined.
While that may sound like a lot, it’s not that bad since Wharf Real Estate Investment has a huge market cap of HK $ 122.4 billion, and so it could likely strengthen its balance sheet by raising capital if needed. However, it is always worth taking a close look at your ability to repay your debt.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
Wharf Real Estate Investment’s net debt to EBITDA ratio is 5.2, which suggests rather high debt levels, but its 9.6 times interest coverage suggests debt servicing is easy. Overall, we would say it seems likely that the company is carrying some pretty heavy debt. Unfortunately, Wharf Real Estate Investment’s EBIT has fallen 14% over the past four quarters. If incomes continue to drop at this rate, it will be more difficult to manage debt than taking three kids under 5 to a fancy pants restaurant. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Wharf Real Estate Investment’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Wharf Real Estate Investment has recorded free cash flow of 78% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
Neither Wharf Real Estate Investment’s ability to manage its debt, based on its EBITDA, nor its EBIT growth rate gave us confidence in its ability to take on more debt. But the good news is that it seems to be able to easily convert EBIT into free cash flow. Looking at all the angles mentioned above, it seems to us that Wharf Real Estate Investment is a somewhat risky investment due to its leverage. This isn’t necessarily a bad thing, as leverage can increase returns on equity, but it’s something to be aware of. 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 off the balance sheet. For example, we discovered 1 warning sign for Wharf Real Estate Investment which you should know before investing here.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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