Is Jujiang Construction Group (HKG:1459) Using Too Much Debt?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Jujiang Construction Group Co., Ltd. (HKG:1459) does carry debt. But should shareholders be worried about its use of debt?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Jujiang Construction Group

How Much Debt Does Jujiang Construction Group Carry?

The chart below, which you can click on for greater detail, shows that Jujiang Construction Group had CN¥648.5m in debt in December 2023; about the same as the year before. On the flip side, it has CN¥397.0m in cash leading to net debt of about CN¥251.4m.

How Healthy Is Jujiang Construction Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jujiang Construction Group had liabilities of CN¥5.05b due within 12 months and liabilities of CN¥138.6m due beyond that. Offsetting this, it had CN¥397.0m in cash and CN¥5.37b in receivables that were due within 12 months. So it can boast CN¥579.3m more liquid assets than total liabilities.

This surplus strongly suggests that Jujiang Construction Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master.

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).

While we wouldn't worry about Jujiang Construction Group's net debt to EBITDA ratio of 3.4, we think its super-low interest cover of 1.8 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even worse, Jujiang Construction Group saw its EBIT tank 55% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Jujiang Construction Group's earnings that will influence how the balance sheet holds up in the future. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Jujiang Construction Group generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Jujiang Construction Group's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its EBIT growth rate. All these things considered, it appears that Jujiang Construction Group can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. We've identified 5 warning signs with Jujiang Construction Group (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.