Is Central China Real Estate (HKG:832) Using Debt Sensibly?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Central China Real Estate Limited (HKG:832) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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 Central China Real Estate

What Is Central China Real Estate's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Central China Real Estate had debt of CN¥28.0b, up from CN¥25.8b in one year. On the flip side, it has CN¥4.69b in cash leading to net debt of about CN¥23.3b.

How Strong Is Central China Real Estate's Balance Sheet?

The latest balance sheet data shows that Central China Real Estate had liabilities of CN¥126.9b due within a year, and liabilities of CN¥1.76b falling due after that. Offsetting these obligations, it had cash of CN¥4.69b as well as receivables valued at CN¥9.41b due within 12 months. So it has liabilities totalling CN¥114.6b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥216.9m 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'd watch its balance sheet closely, without a doubt. At the end of the day, Central China Real Estate would probably need a major re-capitalization if its creditors were to demand repayment. 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 Central China Real Estate 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.

In the last year Central China Real Estate had a loss before interest and tax, and actually shrunk its revenue by 14%, to CN¥25b. That's not what we would hope to see.

Caveat Emptor

While Central China Real Estate's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CN¥993m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. 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 CN¥3.1b in the last year. So we think buying this stock is risky. There's no doubt that we learn most about debt from the balance sheet. 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 3 warning signs for Central China Real Estate (of which 1 is significant!) 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.