Yunnan Metropolitan RealEstate DevelopmentLtd (SHSE:600239) Has No Shortage Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Yunnan Metropolitan RealEstate Development Co.Ltd (SHSE:600239) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Yunnan Metropolitan RealEstate DevelopmentLtd

What Is Yunnan Metropolitan RealEstate DevelopmentLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Yunnan Metropolitan RealEstate DevelopmentLtd had CN¥4.66b of debt, an increase on CN¥3.43b, over one year. On the flip side, it has CN¥799.4m in cash leading to net debt of about CN¥3.86b.

How Strong Is Yunnan Metropolitan RealEstate DevelopmentLtd's Balance Sheet?

We can see from the most recent balance sheet that Yunnan Metropolitan RealEstate DevelopmentLtd had liabilities of CN¥3.48b falling due within a year, and liabilities of CN¥5.81b due beyond that. On the other hand, it had cash of CN¥799.4m and CN¥785.6m worth of receivables due within a year. So it has liabilities totalling CN¥7.71b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's CN¥5.35b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Weak interest cover of 1.1 times and a disturbingly high net debt to EBITDA ratio of 10.7 hit our confidence in Yunnan Metropolitan RealEstate DevelopmentLtd like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that Yunnan Metropolitan RealEstate DevelopmentLtd achieved a positive EBIT of CN¥329m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Yunnan Metropolitan RealEstate DevelopmentLtd 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Yunnan Metropolitan RealEstate DevelopmentLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Yunnan Metropolitan RealEstate DevelopmentLtd's interest cover 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. Having said that, its ability to grow its EBIT isn't such a worry. After considering the datapoints discussed, we think Yunnan Metropolitan RealEstate DevelopmentLtd 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 example - Yunnan Metropolitan RealEstate DevelopmentLtd has 1 warning sign we think 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.

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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.