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.' 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. We note that C&D International Investment Group Limited (HKG:1908) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is C&D International Investment Group's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2022 C&D International Investment Group had CN¥84.1b of debt, an increase on CN¥77.0b, over one year. However, it also had CN¥37.6b in cash, and so its net debt is CN¥46.5b.
How Strong Is C&D International Investment Group's Balance Sheet?
The latest balance sheet data shows that C&D International Investment Group had liabilities of CN¥249.7b due within a year, and liabilities of CN¥75.8b falling due after that. Offsetting these obligations, it had cash of CN¥37.6b as well as receivables valued at CN¥41.8b due within 12 months. So its liabilities total CN¥246.1b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the CN¥27.3b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, C&D International Investment Group would probably need a major re-capitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
As it happens C&D International Investment Group has a fairly concerning net debt to EBITDA ratio of 7.5 but very strong interest coverage of 94.8. So either it has access to very cheap long term debt or that interest expense is going to grow! One way C&D International Investment Group could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 14%, as it did over the last year. 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 C&D International Investment 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, 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, C&D International Investment Group recorded negative free cash flow, in total. 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.
To be frank both C&D International Investment Group's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We're quite clear that we consider C&D International Investment Group to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. 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 C&D International Investment Group (of which 1 is significant!) you should know about.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
C&D International Investment Group
C&D International Investment Group Limited, an investment holding company, engages in the property development, real estate industry chain investment services, and industry investment activities in Mainland China, Hong Kong, Macau, Taiwan, and internationally.
Solid track record with reasonable growth potential.