These 4 Measures Indicate That CITIC (HKG:267) Is Using Debt Extensively

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. We can see that CITIC Limited (HKG:267) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for CITIC

What Is CITIC's Debt?

As you can see below, CITIC had HK$1.31t of debt, at June 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has HK$1.67t in cash, leading to a HK$354.9b net cash position.

How Healthy Is CITIC's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CITIC had liabilities of HK$4.24t due within 12 months and liabilities of HK$3.34t due beyond that. Offsetting these obligations, it had cash of HK$1.67t as well as receivables valued at HK$4.59t due within 12 months. So it has liabilities totalling HK$1.32t more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$179.2b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, CITIC would likely require a major re-capitalisation if it had to pay its creditors today. CITIC 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.

Importantly CITIC's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine CITIC's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While CITIC has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, CITIC recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although CITIC's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$354.9b. And it impressed us with free cash flow of HK$201b, being 74% of its EBIT. Despite the cash, we do find CITIC's level of total liabilities concerning, so we're not particularly comfortable with the stock. 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. Case in point: We've spotted 2 warning signs for CITIC you should be aware of, and 1 of them can't be ignored.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

If you decide to trade CITIC, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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