We believe that China Resources Land (HKG: 1109) is taking risks with its debt
David Iben put it well when he said: âVolatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Above all, China Resources Land Limited (HKG: 1109) carries a debt. But should shareholders be concerned about its use of debt?
When is debt a problem?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider both liquidity and debt levels.
See our latest analysis for China Resources Land
How much debt does China’s resource lands carry?
The image below, which you can click for more details, shows that in June 2021, China Resources Land had a debt of CNN 230.4 billion, compared to CNN 187.1 billion in one year. However, he has CN 97.2 billion in cash offsetting this, which leads to net debt of around CN 133.2 billion.
How strong is China Resources Land’s balance sheet?
The latest balance sheet data shows that China Resources Land had CN 456.6 billion in liabilities maturing within one year, and CN 198.9 billion in liabilities maturing after that. In return, he had CN 97.2 billion in cash and CN 54.7 billion in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of CN 503.6b.
The deficiency here weighs heavily on the CN Â¥ 179.0b company 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. Ultimately, China Resources Land would likely need a major recapitalization if its creditors demanded repayment.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
China Resources Land’s net debt is 2.5 times its EBITDA, which represents significant leverage but still reasonable. However, its interest coverage of 1k is very high, which suggests that interest charges on debt are currently quite low. One way China Resources Land could beat its debt would be to stop borrowing more but continue to increase its EBIT by around 19%, as it did last year. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether China Resources Land can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. It is therefore worth checking to what extent this EBIT is supported by free cash flow. In the past three years, China Resources Land has recorded free cash flow of 61% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
Neither China Resources Land’s ability to manage its total liabilities nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is that he seems to be able to easily cover his interest charges with his EBIT. Looking at all the angles mentioned above, it seems to us that China Resources Land is a somewhat risky investment because of its debt. Not all risks are bad, as they can increase stock price returns if they are profitable, but this risk of leverage is worth keeping in mind. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. Note that China Resources Land displays 2 warning signs in our investment analysis , and 1 of them is significant …
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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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 documents. Simply Wall St has no position in the mentioned stocks.
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