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Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies China Merchants Land Limited (HKG: 978) uses debt. But the most important question is: what risk does this debt create?
When Is Debt a Problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest analysis for China Merchants Land
What is the debt of China Merchants Land?
As you can see below, China Merchants Land had a debt of CNN 20.0 billion in June 2021, compared to CNN 25.7 billion the year before. However, he also had CN 12.5 billion in cash, so his net debt was CN 7.55 billion.
A look at the responsibilities of China Merchants Land
We can see from the most recent balance sheet that China Merchants Land had liabilities of CNN 93.3 billion maturing within one year, and CN debts maturing beyond CN 10.1 billion. . In return, he had CN 12.5 billion in cash and CN 34.4 billion in receivables due within 12 months. It therefore has liabilities totaling CN 56.5 billion more than its cash and short-term receivables combined.
Deficiency here weighs heavily on CN ¥ 3.66b society itself, as if a child struggles under the weight of a huge backpack full of books, his sports equipment and a trumpet. So we would be watching its record closely, without a doubt. After all, China Merchants Land would likely need a major recapitalization if it were to pay its creditors today.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
China Merchants Land’s 1.7x EBITDA net debt suggests a graceful use of debt. And the fact that her last twelve months of EBIT was 9.4 times her interest expense ties in with that theme. In fact, China Merchants Land’s saving grace is its low level of debt, as its EBIT has fallen 22% in the past twelve months. When a business sees its profits accumulate, it can sometimes see its relationship with its lenders deteriorate. There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of China Merchants Land that will influence the balance sheet in the future. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, China Merchants Land has generated free cash flow of a very solid 89% of its EBIT, more than we expected. This positions it well to repay debt if it is desirable.
Our point of view
To be frank, China Merchants Land’s EBIT growth rate and track record of controlling its total liabilities make us rather uncomfortable with its level of leverage. But on the positive side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Overall, we think it’s fair to say that China Merchants Land has enough debt that there is real risk around the balance sheet. If all goes well, it may pay off, but the downside to this debt is an increased risk of permanent losses. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. We have identified 3 warning signs with China Merchants Land, and understanding them should be part of your investment process.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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