We Think Hangzhou Binjiang Real Estate GroupLtd (SZSE:002244) Is Taking Some Risk With Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Hangzhou Binjiang Real Estate Group Co.,Ltd (SZSE:002244) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. 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 Hangzhou Binjiang Real Estate GroupLtd

What Is Hangzhou Binjiang Real Estate GroupLtd's Debt?

The image below, which you can click on for greater detail, shows that Hangzhou Binjiang Real Estate GroupLtd had debt of CN¥60.6b at the end of September 2024, a reduction from CN¥66.5b over a year. However, it also had CN¥29.3b in cash, and so its net debt is CN¥31.2b.

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

Zooming in on the latest balance sheet data, we can see that Hangzhou Binjiang Real Estate GroupLtd had liabilities of CN¥189.7b due within 12 months and liabilities of CN¥29.8b due beyond that. Offsetting this, it had CN¥29.3b in cash and CN¥34.6b in receivables that were due within 12 months. So its liabilities total CN¥155.6b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥27.3b 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 definitely think shareholders need to watch this one closely. 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.

Strangely Hangzhou Binjiang Real Estate GroupLtd has a sky high EBITDA ratio of 11.9, implying high debt, but a strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Shareholders should be aware that Hangzhou Binjiang Real Estate GroupLtd's EBIT was down 71% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. 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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding 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. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, Hangzhou Binjiang Real Estate GroupLtd's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Overall, it seems to us that Hangzhou Binjiang Real Estate GroupLtd's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Hangzhou Binjiang Real Estate GroupLtd (1 doesn't sit too well with us!) that you should be aware of before investing here.

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.