Stock Analysis

We Think Beijing Urban Construction Design & Development Group (HKG:1599) Is Taking Some Risk With Its Debt

SEHK:1599
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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Beijing Urban Construction Design & Development Group Co., Limited (HKG:1599) does use debt in its business. 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Beijing Urban Construction Design & Development Group

How Much Debt Does Beijing Urban Construction Design & Development Group Carry?

As you can see below, at the end of June 2020, Beijing Urban Construction Design & Development Group had CN¥5.10b of debt, up from CN¥4.85b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥2.97b, its net debt is less, at about CN¥2.13b.

debt-equity-history-analysis
SEHK:1599 Debt to Equity History November 30th 2020

A Look At Beijing Urban Construction Design & Development Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Beijing Urban Construction Design & Development Group had liabilities of CN¥9.76b due within 12 months and liabilities of CN¥5.21b due beyond that. Offsetting these obligations, it had cash of CN¥2.97b as well as receivables valued at CN¥7.98b due within 12 months. So it has liabilities totalling CN¥4.03b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥2.32b 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, Beijing Urban Construction Design & Development Group would probably need a major re-capitalization if its creditors were to demand repayment.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Beijing Urban Construction Design & Development Group has a debt to EBITDA ratio of 3.4, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. Sadly, Beijing Urban Construction Design & Development Group's EBIT actually dropped 7.7% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Beijing Urban Construction Design & Development Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Beijing Urban Construction Design & Development Group recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over Beijing Urban Construction Design & Development Group's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But on the bright side, its interest cover is a good sign, and makes us more optimistic. We're quite clear that we consider Beijing Urban Construction Design & Development Group to be really rather risky, as a result of its balance sheet health. 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. Take risks, for example - Beijing Urban Construction Design & Development Group has 2 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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