China Chengtong Development Group (HKG:217) Seems To Be Using A Lot Of Debt

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. We can see that China Chengtong Development Group Limited (HKG:217) does use debt in its business. But should shareholders be worried about its use of debt?

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When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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.

What Is China Chengtong Development Group's Net Debt?

As you can see below, China Chengtong Development Group had HK$4.90b of debt at December 2024, down from HK$6.92b a year prior. However, it also had HK$1.06b in cash, and so its net debt is HK$3.84b.

A Look At China Chengtong Development Group's Liabilities

Zooming in on the latest balance sheet data, we can see that China Chengtong Development Group had liabilities of HK$3.52b due within 12 months and liabilities of HK$2.09b due beyond that. On the other hand, it had cash of HK$1.06b and HK$3.31b worth of receivables due within a year. So its liabilities total HK$1.24b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$709.8m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, China Chengtong Development Group would likely require a major re-capitalisation if it had to pay its creditors today.

Check out our latest analysis for China Chengtong Development Group

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Strangely China Chengtong Development Group has a sky high EBITDA ratio of 19.8, implying high debt, but a strong interest coverage of 11.3. So either it has access to very cheap long term debt or that interest expense is going to grow! Importantly, China Chengtong Development Group's EBIT fell a jaw-dropping 29% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 China Chengtong Development 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, China Chengtong Development Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both China Chengtong Development Group's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Considering all the factors previously mentioned, we think that China Chengtong Development Group really is carrying too much debt. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. 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. For example China Chengtong Development Group has 3 warning signs (and 1 which can't be ignored) we think you should know about.

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.

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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.