China New Town Development (HKG:1278) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, China New Town Development Company Limited (HKG:1278) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for China New Town Development

How Much Debt Does China New Town Development Carry?

As you can see below, China New Town Development had CN¥1.11b of debt, at December 2022, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥2.34b in cash, so it actually has CN¥1.23b net cash.

A Look At China New Town Development's Liabilities

The latest balance sheet data shows that China New Town Development had liabilities of CN¥1.31b due within a year, and liabilities of CN¥741.6m falling due after that. Offsetting these obligations, it had cash of CN¥2.34b as well as receivables valued at CN¥650.4m due within 12 months. So it can boast CN¥948.5m more liquid assets than total liabilities.

This surplus strongly suggests that China New Town Development has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that China New Town Development has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact China New Town Development's saving grace is its low debt levels, because its EBIT has tanked 91% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is China New Town Development's earnings that will influence how the balance sheet holds up in the future. 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. While China New Town Development has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, China New Town Development actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case China New Town Development has CN¥1.23b in net cash and a strong balance sheet. The cherry on top was that in converted 323% of that EBIT to free cash flow, bringing in -CN¥35m. So we don't think China New Town Development's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 5 warning signs for China New Town Development (2 are a bit concerning) you should be aware of.

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.