Does Hao Tian International Construction Investment Group (HKG:1341) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Hao Tian International Construction Investment Group Limited (HKG:1341) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hao Tian International Construction Investment Group

What Is Hao Tian International Construction Investment Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Hao Tian International Construction Investment Group had HK$335.0m of debt, an increase on HK$83.4m, over one year. On the flip side, it has HK$235.0m in cash leading to net debt of about HK$100.0m.

How Strong Is Hao Tian International Construction Investment Group's Balance Sheet?

We can see from the most recent balance sheet that Hao Tian International Construction Investment Group had liabilities of HK$240.0m falling due within a year, and liabilities of HK$249.0m due beyond that. On the other hand, it had cash of HK$235.0m and HK$434.0m worth of receivables due within a year. So it can boast HK$180.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Hao Tian International Construction Investment Group could probably pay off its debt with ease, as its balance sheet is far from stretched.

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).

While Hao Tian International Construction Investment Group has a quite reasonable net debt to EBITDA multiple of 1.5, its interest cover seems weak, at 0.80. The main reason for this is that it has such high depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) Either way there's no doubt the stock is using meaningful leverage. Notably, Hao Tian International Construction Investment Group made a loss at the EBIT level, last year, but improved that to positive EBIT of HK$27m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Hao Tian International Construction Investment Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Hao Tian International Construction Investment Group burned a lot of cash. 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

While Hao Tian International Construction Investment Group's interest cover makes us cautious about it, its track record of converting EBIT to free cash flow is no better. At least its level of total liabilities gives us reason to be optimistic. Looking at all the angles mentioned above, it does seem to us that Hao Tian International Construction Investment Group is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Case in point: We've spotted 1 warning sign for Hao Tian International Construction Investment Group 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. 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.
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