These 4 Measures Indicate That Jianzhong Construction Development (HKG:589) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Jianzhong Construction Development Limited (HKG:589) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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, 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.

Check out our latest analysis for Jianzhong Construction Development

What Is Jianzhong Construction Development's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2020 Jianzhong Construction Development had debt of CN¥113.8m, up from CN¥82.0m in one year. However, its balance sheet shows it holds CN¥193.9m in cash, so it actually has CN¥80.1m net cash.

How Healthy Is Jianzhong Construction Development's Balance Sheet?

We can see from the most recent balance sheet that Jianzhong Construction Development had liabilities of CN¥755.7m falling due within a year, and liabilities of CN¥70.7m due beyond that. On the other hand, it had cash of CN¥193.9m and CN¥1.22b worth of receivables due within a year. So it can boast CN¥583.1m more liquid assets than total liabilities.

This surplus liquidity suggests that Jianzhong Construction Development's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Jianzhong Construction Development has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Jianzhong Construction Development's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Jianzhong Construction Development 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. Jianzhong Construction Development 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. Considering the last three years, Jianzhong Construction Development actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While it is always sensible to investigate a company's debt, in this case Jianzhong Construction Development has CN¥80.1m in net cash and a strong balance sheet. So we are not troubled with Jianzhong Construction Development's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Jianzhong Construction Development is showing 3 warning signs in our investment analysis , and 1 of those shouldn'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.

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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.
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