Landsea Green Properties (HKG:106) Has No Shortage Of 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 note that Landsea Green Properties Co., Ltd. (HKG:106) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Landsea Green Properties

What Is Landsea Green Properties's Debt?

As you can see below, Landsea Green Properties had CN¥6.55b of debt at December 2020, down from CN¥7.98b a year prior. However, it does have CN¥5.13b in cash offsetting this, leading to net debt of about CN¥1.42b.

A Look At Landsea Green Properties' Liabilities

We can see from the most recent balance sheet that Landsea Green Properties had liabilities of CN¥11.5b falling due within a year, and liabilities of CN¥7.69b due beyond that. Offsetting these obligations, it had cash of CN¥5.13b as well as receivables valued at CN¥5.42b due within 12 months. So it has liabilities totalling CN¥8.65b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥2.10b 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, Landsea Green Properties 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Landsea Green Properties's debt to EBITDA ratio (3.0) suggests that it uses some debt, its interest cover is very weak, at 1.4, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even worse, Landsea Green Properties saw its EBIT tank 70% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Landsea Green Properties will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Considering the last three years, Landsea Green Properties actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, Landsea Green Properties'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 even its conversion of EBIT to free cash flow fails to inspire much confidence. Considering all the factors previously mentioned, we think that Landsea Green Properties really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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 2 warning signs for Landsea Green Properties (of which 1 shouldn't be ignored!) you should know about.

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.

If you’re looking to trade Landsea Green Properties, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.