Is China Overseas Property Holdings (HKG:2669) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Overseas Property Holdings Limited (HKG:2669) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China Overseas Property Holdings

How Much Debt Does China Overseas Property Holdings Carry?

The image below, which you can click on for greater detail, shows that at June 2022 China Overseas Property Holdings had debt of HK$449.8m, up from none in one year. But on the other hand it also has HK$3.56b in cash, leading to a HK$3.11b net cash position.

How Healthy Is China Overseas Property Holdings' Balance Sheet?

The latest balance sheet data shows that China Overseas Property Holdings had liabilities of HK$5.65b due within a year, and liabilities of HK$121.6m falling due after that. Offsetting this, it had HK$3.56b in cash and HK$3.06b in receivables that were due within 12 months. So it can boast HK$838.3m more liquid assets than total liabilities.

This surplus suggests that China Overseas Property Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that China Overseas Property Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, China Overseas Property Holdings grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if China Overseas Property Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While China Overseas Property Holdings 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. In the last three years, China Overseas Property Holdings's free cash flow amounted to 44% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Overseas Property Holdings has net cash of HK$3.11b, as well as more liquid assets than liabilities. And we liked the look of last year's 36% year-on-year EBIT growth. So is China Overseas Property Holdings's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in China Overseas Property Holdings, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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

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.