China City Infrastructure Group (HKG:2349) Has Debt But No Earnings; Should You Worry?

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 China City Infrastructure Group Limited (HKG:2349) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for China City Infrastructure Group

What Is China City Infrastructure Group's Net Debt?

The image below, which you can click on for greater detail, shows that China City Infrastructure Group had debt of HK$823.6m at the end of June 2022, a reduction from HK$1.03b over a year. However, because it has a cash reserve of HK$16.7m, its net debt is less, at about HK$806.9m.

How Strong Is China City Infrastructure Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China City Infrastructure Group had liabilities of HK$1.15b due within 12 months and liabilities of HK$439.2m due beyond that. Offsetting this, it had HK$16.7m in cash and HK$23.9m in receivables that were due within 12 months. So it has liabilities totalling HK$1.55b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the HK$240.9m 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, China City Infrastructure Group would likely require a major re-capitalisation if it had to pay its creditors today. 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 China City Infrastructure Group 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.

Over 12 months, China City Infrastructure Group made a loss at the EBIT level, and saw its revenue drop to HK$72m, which is a fall of 15%. That's not what we would hope to see.

Caveat Emptor

Not only did China City Infrastructure Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at HK$19m. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the fact is that it incinerated HK$5.8m of cash in the last twelve months, and has precious few liquid assets in comparison to its liabilities. So is this a high risk stock? We think so, and we'd avoid it. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for China City Infrastructure Group that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.