Is Hebei Construction Group (HKG:1727) Weighed On By Its Debt Load?

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.' 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. We note that Hebei Construction Group Corporation Limited (HKG:1727) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hebei Construction Group

What Is Hebei Construction Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Hebei Construction Group had CN¥5.48b of debt, an increase on CN¥5.19b, over one year. But on the other hand it also has CN¥8.95b in cash, leading to a CN¥3.47b net cash position.

How Healthy Is Hebei Construction Group's Balance Sheet?

We can see from the most recent balance sheet that Hebei Construction Group had liabilities of CN¥59.3b falling due within a year, and liabilities of CN¥1.74b due beyond that. Offsetting these obligations, it had cash of CN¥8.95b as well as receivables valued at CN¥50.6b due within 12 months. So it has liabilities totalling CN¥1.55b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥1.55b, we think shareholders really should watch Hebei Construction Group's debt levels, like a parent watching their child ride a bike for the first time. 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.

Over 12 months, Hebei Construction Group reported revenue of CN¥48b, which is a gain of 19%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

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¥601m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. 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. 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. Be aware that Hebei Construction Group is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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.