Does Beijing Enterprises Urban Resources Group (HKG:3718) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Beijing Enterprises Urban Resources Group Limited (HKG:3718) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Beijing Enterprises Urban Resources Group

How Much Debt Does Beijing Enterprises Urban Resources Group Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Beijing Enterprises Urban Resources Group had debt of HK$1.76b, up from HK$1.39b in one year. However, it also had HK$1.73b in cash, and so its net debt is HK$33.4m.

How Healthy Is Beijing Enterprises Urban Resources Group's Balance Sheet?

According to the last reported balance sheet, Beijing Enterprises Urban Resources Group had liabilities of HK$2.32b due within 12 months, and liabilities of HK$1.13b due beyond 12 months. Offsetting this, it had HK$1.73b in cash and HK$1.65b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$80.9m.

This state of affairs indicates that Beijing Enterprises Urban Resources Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the HK$4.50b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, Beijing Enterprises Urban Resources Group has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Beijing Enterprises Urban Resources Group has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.034 and EBIT of 13.1 times the interest expense. Indeed relative to its earnings its debt load seems light as a feather. In addition to that, we're happy to report that Beijing Enterprises Urban Resources Group has boosted its EBIT by 60%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Beijing Enterprises Urban Resources Group'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Beijing Enterprises Urban Resources Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Beijing Enterprises Urban Resources Group's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Taking all this data into account, it seems to us that Beijing Enterprises Urban Resources Group takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Beijing Enterprises Urban Resources Group is showing 3 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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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