Does CITIC Telecom International Holdings (HKG:1883) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 CITIC Telecom International Holdings Limited (HKG:1883) makes use of debt. But should shareholders be worried about its use of debt?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for CITIC Telecom International Holdings

What Is CITIC Telecom International Holdings's Debt?

As you can see below, CITIC Telecom International Holdings had HK$6.17b of debt at June 2020, down from HK$6.58b a year prior. However, it also had HK$1.34b in cash, and so its net debt is HK$4.83b.

How Strong Is CITIC Telecom International Holdings's Balance Sheet?

We can see from the most recent balance sheet that CITIC Telecom International Holdings had liabilities of HK$2.60b falling due within a year, and liabilities of HK$6.54b due beyond that. Offsetting these obligations, it had cash of HK$1.34b as well as receivables valued at HK$1.84b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$5.96b.

This is a mountain of leverage relative to its market capitalization of HK$8.98b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

CITIC Telecom International Holdings's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 5.3 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. CITIC Telecom International Holdings grew its EBIT by 3.2% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CITIC Telecom International Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, CITIC Telecom International Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

On our analysis CITIC Telecom International Holdings's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to handle its total liabilities. When we consider all the elements mentioned above, it seems to us that CITIC Telecom International Holdings is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with CITIC Telecom International Holdings , and understanding them should be part of your investment process.

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. 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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