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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. 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 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out the opportunities and risks within the HK Real Estate industry.

What Is Gemdale Properties and Investment's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Gemdale Properties and Investment had CN¥33.3b of debt, an increase on CN¥21.9b, over one year. However, it does have CN¥5.54b in cash offsetting this, leading to net debt of about CN¥27.8b.

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¥28.7b falling due within a year, and liabilities of CN¥24.4b due beyond that. On the other hand, it had cash of CN¥5.54b and CN¥6.37b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥41.2b.

This deficit casts a shadow over the CN¥7.51b 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.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.53 times and a disturbingly high net debt to EBITDA ratio of 50.1 hit our confidence in Gemdale Properties and Investment like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Gemdale Properties and Investment's EBIT was down 89% over the last year. 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. 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 Gemdale Properties and Investment will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Gemdale Properties and Investment recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both Gemdale Properties and Investment's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its net debt to EBITDA fails to inspire much confidence. We think the chances that Gemdale Properties and Investment has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. 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. Case in point: We've spotted 3 warning signs for Gemdale Properties and Investment you should be aware of, and 1 of them is significant.

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.