We Think China Greenland Broad Greenstate Group (HKG:1253) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that China Greenland Broad Greenstate Group Company Limited (HKG:1253) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for China Greenland Broad Greenstate Group

What Is China Greenland Broad Greenstate Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that China Greenland Broad Greenstate Group had CN¥744.1m of debt in December 2020, down from CN¥891.3m, one year before. However, it does have CN¥309.3m in cash offsetting this, leading to net debt of about CN¥434.8m.

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

Zooming in on the latest balance sheet data, we can see that China Greenland Broad Greenstate Group had liabilities of CN¥2.15b due within 12 months and liabilities of CN¥276.4m due beyond that. Offsetting these obligations, it had cash of CN¥309.3m as well as receivables valued at CN¥1.81b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥313.6m.

This deficit isn't so bad because China Greenland Broad Greenstate Group is worth CN¥1.00b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

China Greenland Broad Greenstate Group has a debt to EBITDA ratio of 3.0 and its EBIT covered its interest expense 2.9 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The silver lining is that China Greenland Broad Greenstate Group grew its EBIT by 182% last year, which nourishing like the idealism of youth. If that earnings trend continues it will make its debt load much more manageable in the future. There's no doubt that we learn most about debt from the balance sheet. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, China Greenland Broad Greenstate Group's free cash flow amounted to 40% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

When it comes to the balance sheet, the standout positive for China Greenland Broad Greenstate Group was the fact that it seems able to grow its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its interest cover makes us a little nervous about its debt. Looking at all this data makes us feel a little cautious about China Greenland Broad Greenstate Group's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Case in point: We've spotted 3 warning signs for China Greenland Broad Greenstate Group you should be aware of, and 2 of them are a bit unpleasant.

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. 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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