Does Gemdale Properties and Investment (HKG:535) Have A Healthy Balance Sheet?

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, Gemdale Properties and Investment Corporation Limited (HKG:535) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Gemdale Properties and Investment

What Is Gemdale Properties and Investment's Debt?

As you can see below, at the end of December 2021, Gemdale Properties and Investment had CN¥23.0b of debt, up from CN¥18.3b a year ago. Click the image for more detail. However, it does have CN¥8.77b in cash offsetting this, leading to net debt of about CN¥14.2b.

A Look At Gemdale Properties and Investment's Liabilities

We can see from the most recent balance sheet that Gemdale Properties and Investment had liabilities of CN¥31.8b falling due within a year, and liabilities of CN¥20.7b due beyond that. Offsetting these obligations, it had cash of CN¥8.77b as well as receivables valued at CN¥7.07b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥36.6b.

This deficit casts a shadow over the CN¥11.9b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Gemdale Properties and Investment would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Gemdale Properties and Investment shareholders face the double whammy of a high net debt to EBITDA ratio (20.0), and fairly weak interest coverage, since EBIT is just 0.78 times the interest expense. The debt burden here is substantial. Even worse, Gemdale Properties and Investment saw its EBIT tank 86% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is Gemdale Properties and Investment'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Gemdale Properties and Investment barely recorded positive free cash flow, in total. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Our View

On the face of it, Gemdale Properties and Investment's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its net debt to EBITDA also fails to instill confidence. It looks to us like Gemdale Properties and Investment carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Gemdale Properties and Investment is showing 4 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

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. 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.