Health Check: How Prudently Does Hebei Construction Group (HKG:1727) Use Debt?

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. As with many other companies Hebei Construction Group Corporation Limited (HKG:1727) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out the opportunities and risks within the HK Construction industry.

How Much Debt Does Hebei Construction Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Hebei Construction Group had CN¥5.96b of debt, an increase on CN¥5.16b, over one year. However, it does have CN¥7.06b in cash offsetting this, leading to net cash of CN¥1.10b.

How Strong Is Hebei Construction Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hebei Construction Group had liabilities of CN¥54.3b due within 12 months and liabilities of CN¥2.43b due beyond that. Offsetting these obligations, it had cash of CN¥7.06b as well as receivables valued at CN¥47.9b due within 12 months. So it has liabilities totalling CN¥1.70b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's CN¥1.34b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Hebei Construction Group boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hebei Construction Group will need earnings to service that debt. 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.

In the last year Hebei Construction Group had a loss before interest and tax, and actually shrunk its revenue by 2.8%, to CN¥44b. That's not what we would hope to see.

So How Risky Is Hebei Construction Group?

While Hebei Construction Group lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow CN¥610m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Hebei Construction Group you should know about.

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.