Is Wharf Real Estate Investment (HKG:1997) A Risky Investment?

Legendary fund manager Li Lu (who was assisted by Charlie Munger) once said: “The greatest risk to investment is not price volatility, but whether you experience permanent capital loss.” So it might be obvious that you need to consider debt when thinking about how risky a particular stock is, as too much debt can bring a company down. As with many other companies Wharf Real Estate Investment Company Limited (HKG: 1997) makes use of debt. But does this debt worry shareholders?

When is debt a problem?

Debt and other liabilities become risky for a company when it cannot meet those obligations easily, 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. However, a more common (but still expensive) situation is that a company needs to water down shareholders at a cheap stock price just to get a grip on debt. The advantage of debt, of course, is that it is often cheap capital, especially when it replaces the dilution of a business with the ability to reinvest too high a return. When we think about using a company’s debt, let’s first look at cash and debt together.

Check out our latest analysis for Wharf Real Estate Investment

How much debt does Wharf Real Estate Investment owe?

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 previous year. However, it also had HK $ 2.95 billion in cash, so its net debt is HK $ 50.4 billion.

SEHK: 1997 Debt to Equity History October 1, 2021

How strong is the Wharf Real Estate Investment balance sheet?

According to the most recently published balance sheet, Wharf Real Estate Investment had 12 months in debt totaling $ 11.5 billion. HK $ 25 billion due within 12 months. So it has total liabilities of HK $ 61.9 billion more than its cash and short-term receivables combined.

While this may seem like a lot, it’s not that bad given Wharf Real Estate Investment’s massive market cap of $ 122.4 billion. Still, it’s worth taking a close look at debt repayment.

To estimate a company’s debt in relation to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its interest expense (its interest coverage). Therefore, we consider debt relative to earnings both with and without depreciation.

Wharf Real Estate Investment’s net debt to EBITDA ratio is 5.2, which suggests quite a high level of debt, but interest coverage of 9.6 times suggests that the debt is easy to service. Overall, we’d say the company is likely to have a fairly high mountain of debt. Unfortunately, Wharf Real Estate Investment’s EBIT flopped 14% over the past four quarters. If revenues continue to decline at this rate, it will be more difficult to deal with the debt than bringing three kids under the age of 5 to a fancy pants restaurant. When analyzing debt levels, the obvious starting point is the balance sheet. But, more than anything, future returns will determine Wharf Real Estate Investment’s ability to continue to maintain healthy balance sheets. So if you are focused on the future, this is what you can check out here for free Analyst earnings forecast report.

But our final consideration is also important because a company cannot pay its debts with paper profits; it takes cold cash. So we have to see clearly whether this EBIT leads to a corresponding free cash flow. For the past three years, Wharf Real Estate Investment has posted free cash flow equal to 78% of its EBIT, which is roughly normal as the free cash flow is excluding interest and taxes. This cold money means it can get rid of its debt if it wants to.

Our view

Neither Wharf Real Estate Investment’s ability to manage its debt based on EBITDA nor its EBIT growth rate gave us confidence in its ability to take on more debt. The good news, however, is that EBIT can be easily converted to free cash flow. From all of the above, Wharf Real Estate Investment seems to us to be a somewhat risky investment due to its indebtedness. This isn’t necessarily a bad thing as leverage can increase returns on equity, but one should be aware of that. When analyzing debt levels, the obvious starting point is the balance sheet. But ultimately, any business can involve off-balance sheet risks. For example we discovered 1 warning sign for Wharf Real Estate Investment that you should know before investing here.

Ultimately, sometimes it’s easier to focus on businesses that don’t even need debt. Readers can access a list of growth stocks with no net debt 100% free, at the moment.

This article from Simply Wall St is of a general nature. We only provide comments based on historical data and analyst projections using an unbiased methodology, and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. Our goal is to provide you with long-term, focused analysis based on fundamentals. Note that our analysis may not take into account the latest company announcements or quality material, which may be sensitive to the price. Simply Wall St has no position in the stocks mentioned.

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