Health Check: How Prudently Does China Public Procurement (HKG:1094) Use Debt?

Simply Wall St
September 07, 2021
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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies China Public Procurement Limited (HKG:1094) makes use of debt. But the real question is whether this debt is making the company risky.

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, 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for China Public Procurement

What Is China Public Procurement's Debt?

As you can see below, China Public Procurement had HK$28.9m of debt at June 2021, down from HK$30.7m a year prior. However, it also had HK$8.92m in cash, and so its net debt is HK$20.0m.

SEHK:1094 Debt to Equity History September 7th 2021

How Strong Is China Public Procurement's Balance Sheet?

The latest balance sheet data shows that China Public Procurement had liabilities of HK$81.1m due within a year, and liabilities of HK$75.2m falling due after that. Offsetting this, it had HK$8.92m in cash and HK$12.9m in receivables that were due within 12 months. So it has liabilities totalling HK$134.5m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of HK$102.6m, we think shareholders really should watch China Public Procurement's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Public Procurement's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year China Public Procurement wasn't profitable at an EBIT level, but managed to grow its revenue by 32%, to HK$100m. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though China Public Procurement managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost a very considerable HK$12m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of HK$1.0m and the profit of HK$5.2m. So one might argue that there's still a chance it can get things on the right track. 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. Be aware that China Public Procurement is showing 3 warning signs in our investment analysis , 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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