Is CITIC Guoan Information Industry (SZSE:000839) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies CITIC Guoan Information Industry Co., Ltd. (SZSE:000839) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for CITIC Guoan Information Industry

What Is CITIC Guoan Information Industry's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 CITIC Guoan Information Industry had debt of CN¥2.53b, up from CN¥2.03b in one year. However, because it has a cash reserve of CN¥392.4m, its net debt is less, at about CN¥2.14b.

How Strong Is CITIC Guoan Information Industry's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CITIC Guoan Information Industry had liabilities of CN¥2.57b due within 12 months and liabilities of CN¥2.85b due beyond that. Offsetting this, it had CN¥392.4m in cash and CN¥1.18b in receivables that were due within 12 months. So it has liabilities totalling CN¥3.85b more than its cash and near-term receivables, combined.

This deficit isn't so bad because CITIC Guoan Information Industry is worth CN¥14.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 2.2 times and a disturbingly high net debt to EBITDA ratio of 7.6 hit our confidence in CITIC Guoan Information Industry like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that CITIC Guoan Information Industry achieved a positive EBIT of CN¥283m in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since CITIC Guoan Information Industry will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, CITIC Guoan Information Industry burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, CITIC Guoan Information Industry's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least its level of total liabilities is not so bad. Looking at the bigger picture, it seems clear to us that CITIC Guoan Information Industry's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for CITIC Guoan Information Industry (of which 1 is significant!) you should know about.

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.