Is China Qinfa Group (HKG:866) Using Too Much Debt?

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.' 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 note that China Qinfa Group Limited (HKG:866) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for China Qinfa Group

How Much Debt Does China Qinfa Group Carry?

You can click the graphic below for the historical numbers, but it shows that China Qinfa Group had CN¥3.69b of debt in December 2021, down from CN¥4.60b, one year before. However, it also had CN¥1.05b in cash, and so its net debt is CN¥2.64b.

How Healthy Is China Qinfa Group's Balance Sheet?

We can see from the most recent balance sheet that China Qinfa Group had liabilities of CN¥4.58b falling due within a year, and liabilities of CN¥3.00b due beyond that. On the other hand, it had cash of CN¥1.05b and CN¥182.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.35b.

This deficit casts a shadow over the CN¥854.7m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, China Qinfa Group would likely require a major re-capitalisation if it had to pay its creditors today.

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 Qinfa Group's net debt is only 0.41 times its EBITDA. And its EBIT covers its interest expense a whopping 20.3 times over. So we're pretty relaxed about its super-conservative use of debt. Although China Qinfa Group made a loss at the EBIT level, last year, it was also good to see that it generated CN¥3.0b in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is China Qinfa Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Considering the last year, China Qinfa Group 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.

Our View

We'd go so far as to say China Qinfa Group's level of total liabilities was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Overall, we think it's fair to say that China Qinfa Group has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. For instance, we've identified 3 warning signs for China Qinfa Group that you should be aware of.

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. 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.