Is New City Development Group (HKG:456) Using Debt Sensibly?

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. We can see that New City Development Group Limited (HKG:456) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for New City Development Group

What Is New City Development Group's Net Debt?

As you can see below, New City Development Group had HK$730.2m of debt at June 2023, down from HK$834.1m a year prior. However, it does have HK$35.0m in cash offsetting this, leading to net debt of about HK$695.2m.

How Strong Is New City Development Group's Balance Sheet?

We can see from the most recent balance sheet that New City Development Group had liabilities of HK$247.8m falling due within a year, and liabilities of HK$1.19b due beyond that. Offsetting these obligations, it had cash of HK$35.0m as well as receivables valued at HK$1.67m due within 12 months. So it has liabilities totalling HK$1.40b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the HK$56.3m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, New City Development Group would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is New City Development 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.

In the last year New City Development Group managed to produce its first revenue as a listed company, but given the lack of profit, shareholders will no doubt be hoping to see some strong increases.

Caveat Emptor

Over the last twelve months New City Development Group produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping HK$76m. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it lost HK$72m in the last year. So we're not very excited about owning this stock. Its too risky for us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that New City Development Group is showing 5 warning signs in our investment analysis , and 3 of those are concerning...

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.