Here's Why Hebei Construction Group (HKG:1727) Has A Meaningful Debt Burden

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Hebei Construction Group Corporation Limited (HKG:1727) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hebei Construction Group

How Much Debt Does Hebei Construction Group Carry?

As you can see below, at the end of June 2023, Hebei Construction Group had CN¥6.30b of debt, up from CN¥5.96b a year ago. Click the image for more detail. But on the other hand it also has CN¥7.93b in cash, leading to a CN¥1.63b net cash position.

How Healthy Is Hebei Construction Group's Balance Sheet?

The latest balance sheet data shows that Hebei Construction Group had liabilities of CN¥52.9b due within a year, and liabilities of CN¥2.77b falling due after that. Offsetting these obligations, it had cash of CN¥7.93b as well as receivables valued at CN¥46.0b due within 12 months. So its liabilities total CN¥1.75b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥869.0m 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, Hebei Construction Group would probably need a major re-capitalization if its creditors were to demand repayment. Given that Hebei Construction Group has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Notably, Hebei Construction Group made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥727m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hebei Construction 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Hebei Construction Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last year, Hebei Construction Group generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While Hebei Construction Group does have more liabilities than liquid assets, it also has net cash of CN¥1.63b. The cherry on top was that in converted 93% of that EBIT to free cash flow, bringing in CN¥678m. So although we see some areas for improvement, we're not too worried about Hebei Construction Group's balance sheet. 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 1 warning sign with Hebei Construction Group , 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.