Is China Jinmao Holdings Group (HKG:817) A Risky Investment?

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.' 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. We note that China Jinmao Holdings Group Limited (HKG:817) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for China Jinmao Holdings Group

What Is China Jinmao Holdings Group's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2023 China Jinmao Holdings Group had debt of CN¥127.7b, up from CN¥114.2b in one year. On the flip side, it has CN¥32.9b in cash leading to net debt of about CN¥94.7b.

How Strong Is China Jinmao Holdings Group's Balance Sheet?

We can see from the most recent balance sheet that China Jinmao Holdings Group had liabilities of CN¥190.6b falling due within a year, and liabilities of CN¥127.1b due beyond that. Offsetting these obligations, it had cash of CN¥32.9b as well as receivables valued at CN¥26.7b due within 12 months. So its liabilities total CN¥258.1b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥14.2b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, China Jinmao Holdings Group would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely China Jinmao Holdings Group has a sky high EBITDA ratio of 21.2, implying high debt, but a strong interest coverage of 26.9. So either it has access to very cheap long term debt or that interest expense is going to grow! Importantly, China Jinmao Holdings Group's EBIT fell a jaw-dropping 58% in the last twelve months. 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 Jinmao Holdings Group 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, China Jinmao Holdings Group produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

To be frank both China Jinmao Holdings Group's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, it seems to us that China Jinmao Holdings Group's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 Jinmao Holdings Group is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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.