We Think Hebei Construction Group (HKG:1727) Can Stay On Top Of Its Debt

Warren Buffett famously said, '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 Hebei Construction Group Corporation Limited (HKG:1727) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Hebei Construction Group

What Is Hebei Construction Group's Net Debt?

As you can see below, Hebei Construction Group had CN¥5.18b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥8.45b in cash to offset that, meaning it has CN¥3.27b net cash.

A Look At Hebei Construction Group's Liabilities

According to the last reported balance sheet, Hebei Construction Group had liabilities of CN¥54.4b due within 12 months, and liabilities of CN¥1.98b due beyond 12 months. Offsetting this, it had CN¥8.45b in cash and CN¥48.1b in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

This short term liquidity is a sign that Hebei Construction Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Hebei Construction Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Unfortunately, Hebei Construction Group saw its EBIT slide 8.6% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. Looking at the most recent three years, Hebei Construction Group recorded free cash flow of 21% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Hebei Construction Group has CN¥3.27b in net cash and a decent-looking balance sheet. So we don't have any problem with Hebei Construction Group's use of debt. 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. To that end, you should learn about the 4 warning signs we've spotted with Hebei Construction Group (including 2 which make us uncomfortable) .

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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