China Beidahuang Industry Group Holdings (HKG:39) Has No Shortage Of Debt

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.' 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. We can see that China Beidahuang Industry Group Holdings Limited (HKG:39) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for China Beidahuang Industry Group Holdings

What Is China Beidahuang Industry Group Holdings's Debt?

The image below, which you can click on for greater detail, shows that China Beidahuang Industry Group Holdings had debt of HK$504.9m at the end of December 2020, a reduction from HK$548.6m over a year. On the flip side, it has HK$26.1m in cash leading to net debt of about HK$478.8m.

How Healthy Is China Beidahuang Industry Group Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Beidahuang Industry Group Holdings had liabilities of HK$1.01b due within 12 months and liabilities of HK$710.8m due beyond that. Offsetting these obligations, it had cash of HK$26.1m as well as receivables valued at HK$462.1m due within 12 months. So it has liabilities totalling HK$1.24b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the HK$541.6m 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. After all, China Beidahuang Industry Group Holdings 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.47 times and a disturbingly high net debt to EBITDA ratio of 6.2 hit our confidence in China Beidahuang Industry Group Holdings like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that China Beidahuang Industry Group Holdings achieved a positive EBIT of HK$48m in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Beidahuang Industry Group Holdings will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, China Beidahuang Industry Group Holdings recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, China Beidahuang Industry Group Holdings's interest cover 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. Having said that, its ability to grow its EBIT isn't such a worry. After considering the datapoints discussed, we think China Beidahuang Industry Group Holdings has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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 3 warning signs for China Beidahuang Industry Group Holdings you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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.
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