China Overseas Property Holdings (HKG:2669) Could Easily Take On More Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that China Overseas Property Holdings Limited (HKG:2669) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for China Overseas Property Holdings

What Is China Overseas Property Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that China Overseas Property Holdings had HK$51.6m of debt in June 2023, down from HK$449.8m, one year before. But it also has HK$4.27b in cash to offset that, meaning it has HK$4.21b net cash.

A Look At China Overseas Property Holdings' Liabilities

We can see from the most recent balance sheet that China Overseas Property Holdings had liabilities of HK$6.24b falling due within a year, and liabilities of HK$92.9m due beyond that. On the other hand, it had cash of HK$4.27b and HK$3.57b worth of receivables due within a year. So it actually has HK$1.50b more liquid assets than total liabilities.

This surplus suggests that China Overseas Property Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that China Overseas Property Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that China Overseas Property Holdings has been able to increase its EBIT by 29% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China Overseas Property Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While China Overseas Property Holdings 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. Over the most recent three years, China Overseas Property Holdings recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Overseas Property Holdings has net cash of HK$4.21b, as well as more liquid assets than liabilities. And we liked the look of last year's 29% year-on-year EBIT growth. So is China Overseas Property Holdings's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in China Overseas Property Holdings, you may well want to click here to check an interactive graph of its earnings per share history.

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.