Is Hangzhou Binjiang Real Estate GroupLtd (SZSE:002244) Using Too Much Debt?

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 Hangzhou Binjiang Real Estate Group Co.,Ltd (SZSE:002244) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hangzhou Binjiang Real Estate GroupLtd

What Is Hangzhou Binjiang Real Estate GroupLtd's Net Debt?

As you can see below, Hangzhou Binjiang Real Estate GroupLtd had CN¥66.5b of debt at September 2023, down from CN¥78.2b a year prior. On the flip side, it has CN¥30.0b in cash leading to net debt of about CN¥36.5b.

How Healthy Is Hangzhou Binjiang Real Estate GroupLtd's Balance Sheet?

We can see from the most recent balance sheet that Hangzhou Binjiang Real Estate GroupLtd had liabilities of CN¥213.8b falling due within a year, and liabilities of CN¥30.2b due beyond that. Offsetting this, it had CN¥30.0b in cash and CN¥41.7b in receivables that were due within 12 months. So its liabilities total CN¥172.2b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥20.2b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Hangzhou Binjiang Real Estate GroupLtd would probably need a major re-capitalization if its creditors were to demand repayment.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Hangzhou Binjiang Real Estate GroupLtd's net debt is 4.8 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. It is well worth noting that Hangzhou Binjiang Real Estate GroupLtd's EBIT shot up like bamboo after rain, gaining 35% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hangzhou Binjiang Real Estate GroupLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Hangzhou Binjiang Real Estate GroupLtd actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Hangzhou Binjiang Real Estate GroupLtd's level of total liabilities was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Hangzhou Binjiang Real Estate GroupLtd's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Hangzhou Binjiang Real Estate GroupLtd is showing 3 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.