Is CIFI Holdings (Group) (HKG:884) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 CIFI Holdings (Group) Co. Ltd. (HKG:884) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for CIFI Holdings (Group)

What Is CIFI Holdings (Group)'s Debt?

As you can see below, CIFI Holdings (Group) had CN¥88.6b of debt at June 2024, down from CN¥102.2b a year prior. On the flip side, it has CN¥11.4b in cash leading to net debt of about CN¥77.2b.

How Strong Is CIFI Holdings (Group)'s Balance Sheet?

According to the last reported balance sheet, CIFI Holdings (Group) had liabilities of CN¥198.3b due within 12 months, and liabilities of CN¥27.3b due beyond 12 months. On the other hand, it had cash of CN¥11.4b and CN¥73.3b worth of receivables due within a year. So its liabilities total CN¥140.9b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥4.40b 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. After all, CIFI 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). 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 0.46 times and a disturbingly high net debt to EBITDA ratio of 45.7 hit our confidence in CIFI Holdings (Group) like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for CIFI Holdings (Group) is that it turned last year's EBIT loss into a gain of CN¥1.5b, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if CIFI 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, CIFI Holdings (Group) actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, CIFI Holdings (Group)'s interest cover 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 on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We're quite clear that we consider CIFI Holdings (Group) to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. For instance, we've identified 2 warning signs for CIFI Holdings (Group) that you should be aware of.

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.