China Greenland Broad Greenstate Group (HKG:1253) Has A Somewhat Strained Balance Sheet

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, China Greenland Broad Greenstate Group Company Limited (HKG:1253) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for China Greenland Broad Greenstate Group

How Much Debt Does China Greenland Broad Greenstate Group Carry?

You can click the graphic below for the historical numbers, but it shows that China Greenland Broad Greenstate Group had CN¥769.2m of debt in December 2021, down from CN¥805.8m, one year before. However, it does have CN¥77.5m in cash offsetting this, leading to net debt of about CN¥691.7m.

How Healthy Is China Greenland Broad Greenstate Group's Balance Sheet?

We can see from the most recent balance sheet that China Greenland Broad Greenstate Group had liabilities of CN¥2.00b falling due within a year, and liabilities of CN¥318.9m due beyond that. Offsetting this, it had CN¥77.5m in cash and CN¥1.54b in receivables that were due within 12 months. So it has liabilities totalling CN¥699.4m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥844.4m, so it does suggest shareholders should keep an eye on China Greenland Broad Greenstate Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

China Greenland Broad Greenstate Group shareholders face the double whammy of a high net debt to EBITDA ratio (18.6), and fairly weak interest coverage, since EBIT is just 0.90 times the interest expense. The debt burden here is substantial. Even worse, China Greenland Broad Greenstate Group saw its EBIT tank 67% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Greenland Broad Greenstate 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, China Greenland Broad Greenstate Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

To be frank both China Greenland Broad Greenstate Group's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the bigger picture, it seems clear to us that China Greenland Broad Greenstate Group's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the 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. For example China Greenland Broad Greenstate Group has 5 warning signs (and 2 which don't sit too well with us) we think you should know about.

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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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.