Is China New Town Development (HKG:1278) A Risky Investment?

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. Importantly, China New Town Development Company Limited (HKG:1278) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for China New Town Development

How Much Debt Does China New Town Development Carry?

As you can see below, China New Town Development had CN¥879.3m of debt at June 2021, down from CN¥2.19b a year prior. However, its balance sheet shows it holds CN¥2.54b in cash, so it actually has CN¥1.66b net cash.

A Look At China New Town Development's Liabilities

The latest balance sheet data shows that China New Town Development had liabilities of CN¥1.10b due within a year, and liabilities of CN¥826.7m falling due after that. Offsetting this, it had CN¥2.54b in cash and CN¥711.7m in receivables that were due within 12 months. So it actually has CN¥1.32b more liquid assets than total liabilities.

This surplus liquidity suggests that China New Town Development's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, China New Town Development boasts net cash, so it's fair to say it does not have a heavy debt load!

It is well worth noting that China New Town Development's EBIT shot up like bamboo after rain, gaining 82% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is China New Town Development's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While China New Town Development has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, China New Town Development actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, the bottom line is that China New Town Development has net cash of CN¥1.66b and plenty of liquid assets. And it impressed us with free cash flow of CN¥457m, being 149% of its EBIT. The bottom line is that we do not find China New Town Development's debt levels at all concerning. 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 example China New Town Development has 2 warning signs (and 1 which is concerning) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.
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