Does China Overseas Land & Investment (HKG:688) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies China Overseas Land & Investment Limited (HKG:688) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is China Overseas Land & Investment's Debt?

As you can see below, China Overseas Land & Investment had CN¥241.6b of debt at December 2024, down from CN¥259.7b a year prior. However, because it has a cash reserve of CN¥139.8b, its net debt is less, at about CN¥101.8b.

How Strong Is China Overseas Land & Investment's Balance Sheet?

The latest balance sheet data shows that China Overseas Land & Investment had liabilities of CN¥265.2b due within a year, and liabilities of CN¥241.6b falling due after that. Offsetting this, it had CN¥139.8b in cash and CN¥15.4b in receivables that were due within 12 months. So it has liabilities totalling CN¥351.7b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥135.8b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, China Overseas Land & Investment would likely require a major re-capitalisation if it had to pay its creditors today.

View our latest analysis for China Overseas Land & Investment

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

China Overseas Land & Investment's net debt is 3.8 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 28.1 is very high, suggesting that the interest expense on the debt is currently quite low. Shareholders should be aware that China Overseas Land & Investment's EBIT was down 23% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Land & Investment can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, China Overseas Land & Investment recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On the face of it, China Overseas Land & 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. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. After considering the datapoints discussed, we think China Overseas Land & Investment has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for China Overseas Land & Investment you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.