Central China Real Estate (HKG:832) Has Debt But No Earnings; Should You Worry?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Central China Real Estate Limited (HKG:832) makes use of debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Central China Real Estate

What Is Central China Real Estate's Net Debt?

The image below, which you can click on for greater detail, shows that Central China Real Estate had debt of CN¥25.8b at the end of June 2022, a reduction from CN¥28.5b over a year. However, it also had CN¥19.4b in cash, and so its net debt is CN¥6.36b.

How Strong Is Central China Real Estate's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Central China Real Estate had liabilities of CN¥123.4b due within 12 months and liabilities of CN¥16.3b due beyond that. Offsetting these obligations, it had cash of CN¥19.4b as well as receivables valued at CN¥9.34b due within 12 months. So its liabilities total CN¥110.9b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥1.28b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Central China Real Estate would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Central China Real Estate 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.

Over 12 months, Central China Real Estate made a loss at the EBIT level, and saw its revenue drop to CN¥29b, which is a fall of 43%. To be frank that doesn't bode well.

Caveat Emptor

While Central China Real Estate's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CN¥898m at the EBIT level. 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 reality is that it is low on liquid assets relative to liabilities, and it lost CN¥5.7b in the last year. So we think buying this stock is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Central China Real Estate (of which 2 don't sit too well with us!) you should know about.

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.