Health Check: How Prudently Does China New Town Development (HKG:1278) Use Debt?

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.' 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. As with many other companies China New Town Development Company Limited (HKG:1278) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for China New Town Development

What Is China New Town Development's Net Debt?

As you can see below, at the end of June 2023, China New Town Development had CN¥2.60b of debt, up from CN¥1.13b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥3.11b in cash, so it actually has CN¥510.7m net cash.

How Healthy Is China New Town Development's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China New Town Development had liabilities of CN¥1.21b due within 12 months and liabilities of CN¥2.34b due beyond that. Offsetting these obligations, it had cash of CN¥3.11b as well as receivables valued at CN¥667.8m due within 12 months. So it can boast CN¥227.4m 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). On this view, lenders should feel as safe as the beloved of a black-belt karate master. 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. 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 New Town Development 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.

Over 12 months, China New Town Development reported revenue of CN¥307m, which is a gain of 7.0%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

So How Risky Is China New Town Development?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year China New Town Development had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through CN¥25m of cash and made a loss of CN¥22m. With only CN¥510.7m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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. Be aware that China New Town Development is showing 4 warning signs in our investment analysis , and 2 of those make us uncomfortable...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.