Is Poly Developments and Holdings Group (SHSE:600048) 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Poly Developments and Holdings Group Co., Ltd. (SHSE:600048) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

What Is Poly Developments and Holdings Group's Debt?

The chart below, which you can click on for greater detail, shows that Poly Developments and Holdings Group had CN¥354.9b in debt in September 2024; about the same as the year before. However, it also had CN¥127.8b in cash, and so its net debt is CN¥227.1b.

How Strong Is Poly Developments and Holdings Group's Balance Sheet?

According to the last reported balance sheet, Poly Developments and Holdings Group had liabilities of CN¥732.6b due within 12 months, and liabilities of CN¥296.3b due beyond 12 months. Offsetting these obligations, it had cash of CN¥127.8b as well as receivables valued at CN¥149.5b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥751.6b.

This deficit casts a shadow over the CN¥100.3b 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, Poly Developments and Holdings Group would probably need a major re-capitalization if its creditors were to demand repayment.

Check out our latest analysis for Poly Developments and Holdings Group

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

As it happens Poly Developments and Holdings Group has a fairly concerning net debt to EBITDA ratio of 9.9 but very strong interest coverage of 15.2. So either it has access to very cheap long term debt or that interest expense is going to grow! Shareholders should be aware that Poly Developments and Holdings Group's EBIT was down 35% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Poly Developments and Holdings Group can strengthen its balance sheet over time. 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. Looking at the most recent three years, Poly Developments and Holdings Group recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both Poly Developments and Holdings Group's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Taking into account all the aforementioned factors, it looks like Poly Developments and Holdings Group has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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 instance, we've identified 3 warning signs for Poly Developments and Holdings Group (1 is significant) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.