Gemdale Properties and Investment (HKG:535) Has No Shortage Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Gemdale Properties and Investment Corporation Limited (HKG:535) does use debt in its business. But the real question is whether this debt is making the company risky.

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Gemdale Properties and Investment

What Is Gemdale Properties and Investment's Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Gemdale Properties and Investment had debt of CN¥24.4b, up from CN¥23.0b in one year. On the flip side, it has CN¥6.05b in cash leading to net debt of about CN¥18.3b.

How Strong Is Gemdale Properties and Investment's Balance Sheet?

We can see from the most recent balance sheet that Gemdale Properties and Investment had liabilities of CN¥34.8b falling due within a year, and liabilities of CN¥24.2b due beyond that. Offsetting this, it had CN¥6.05b in cash and CN¥8.73b in receivables that were due within 12 months. So its liabilities total CN¥44.2b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥7.23b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Gemdale Properties and Investment would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.013 times and a disturbingly high net debt to EBITDA ratio of 448 hit our confidence in Gemdale Properties and Investment like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Gemdale Properties and Investment saw its EBIT tank 99% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Gemdale Properties and Investment 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Gemdale Properties and Investment saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Gemdale Properties and Investment's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its interest cover also fails to instill confidence. Considering everything we've mentioned above, it's fair to say that Gemdale Properties and Investment is carrying heavy debt load. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Gemdale Properties and Investment you should be aware of, and 1 of them is significant.

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.