We Think China Logistics Property Holdings (HKG:1589) Is Taking Some Risk With Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, China Logistics Property Holdings Co., Ltd (HKG:1589) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for China Logistics Property Holdings

What Is China Logistics Property Holdings's Debt?

The image below, which you can click on for greater detail, shows that at June 2020 China Logistics Property Holdings had debt of CN¥8.80b, up from CN¥7.99b in one year. However, it does have CN¥1.23b in cash offsetting this, leading to net debt of about CN¥7.57b.

How Healthy Is China Logistics Property Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Logistics Property Holdings had liabilities of CN¥2.45b due within 12 months and liabilities of CN¥9.04b due beyond that. Offsetting these obligations, it had cash of CN¥1.23b as well as receivables valued at CN¥462.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥9.79b.

This deficit is considerable relative to its market capitalization of CN¥10.6b, so it does suggest shareholders should keep an eye on China Logistics Property Holdings's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

China Logistics Property Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (16.3), and fairly weak interest coverage, since EBIT is just 0.99 times the interest expense. This means we'd consider it to have a heavy debt load. On a slightly more positive note, China Logistics Property Holdings grew its EBIT at 10% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China Logistics Property Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, China Logistics Property Holdings 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.

Our View

China Logistics Property Holdings's interest cover and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Taking the abovementioned factors together we do think China Logistics Property Holdings's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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, we've discovered 4 warning signs for China Logistics Property Holdings (2 are significant!) that you should be aware of before investing here.

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. 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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