Is China Ocean Group Development (HKG:8047) Using Too Much 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 Ocean Group Development Limited (HKG:8047) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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 our latest analysis for China Ocean Group Development

How Much Debt Does China Ocean Group Development Carry?

As you can see below, at the end of March 2021, China Ocean Group Development had HK$225.3m of debt, up from HK$197.1m a year ago. Click the image for more detail. However, because it has a cash reserve of HK$20.4m, its net debt is less, at about HK$204.9m.

A Look At China Ocean Group Development's Liabilities

According to the last reported balance sheet, China Ocean Group Development had liabilities of HK$318.2m due within 12 months, and liabilities of HK$156.6m due beyond 12 months. Offsetting these obligations, it had cash of HK$20.4m as well as receivables valued at HK$499.8m due within 12 months. So it can boast HK$45.4m more liquid assets than total liabilities.

This short term liquidity is a sign that China Ocean Group Development could probably pay off its debt with ease, as its balance sheet is far from stretched. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Ocean Group Development'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 Ocean Group Development had a loss before interest and tax, and actually shrunk its revenue by 25%, to HK$622m. To be frank that doesn't bode well.

Caveat Emptor

While China Ocean Group Development'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 HK$205m at the EBIT level. Looking on the brighter side, the business has adequate liquid assets, which give it time to grow and develop before its debt becomes a near-term issue. Still, we'd be more encouraged to study the business in depth if it already had some free cash flow. So it seems too risky for our taste. 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. We've identified 3 warning signs with China Ocean Group Development , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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