New City Development Group (HKG:456) 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.' 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. We can see that New City Development Group Limited (HKG:456) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for New City Development Group

What Is New City Development Group's Net Debt?

As you can see below, at the end of December 2020, New City Development Group had HK$550.4m of debt, up from HK$405.2m a year ago. Click the image for more detail. However, it also had HK$78.0m in cash, and so its net debt is HK$472.3m.

How Healthy Is New City Development Group's Balance Sheet?

According to the last reported balance sheet, New City Development Group had liabilities of HK$78.0m due within 12 months, and liabilities of HK$1.06b due beyond 12 months. On the other hand, it had cash of HK$78.0m and HK$1.11m worth of receivables due within a year. So its liabilities total HK$1.06b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$398.1m 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. At the end of the day, New City Development Group would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is New City Development Group'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.

Over 12 months, New City Development Group made a loss at the EBIT level, and saw its revenue drop to HK$47m, which is a fall of 3.4%. That's not what we would hope to see.

Caveat Emptor

Importantly, New City Development Group had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost HK$17m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it vaporized HK$76m in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. 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. Case in point: We've spotted 3 warning signs for New City Development Group you should be aware of, and 2 of them are potentially serious.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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