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Is China New Town Development (HKG:1278) Using Too Much Debt?

Simply Wall St

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that China New Town Development Company Limited (HKG:1278) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for China New Town Development

What Is China New Town Development's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2019 China New Town Development had CN¥2.85b of debt, an increase on CN¥2.06b, over one year. However, its balance sheet shows it holds CN¥3.68b in cash, so it actually has CN¥821.9m net cash.

SEHK:1278 Historical Debt, August 17th 2019

How Strong Is China New Town Development's Balance Sheet?

According to the last reported balance sheet, China New Town Development had liabilities of CN¥2.07b due within 12 months, and liabilities of CN¥2.26b due beyond 12 months. On the other hand, it had cash of CN¥3.68b and CN¥1.28b worth of receivables due within a year. So it can boast CN¥620.0m more liquid assets than total liabilities.

This excess liquidity is a great indication that China New Town Development's balance sheet is just as strong as racists are weak. On this view, it seems its balance sheet is as strong as a black-belt karate master. Succinctly put, China New Town Development boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that China New Town Development's EBIT was down 92% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is China New Town 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. China New Town Development may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, China New Town Development burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case China New Town Development has CN¥822m in net cash and a decent-looking balance sheet. So while China New Town Development does not have a great balance sheet, it's certainly not too bad. Given China New Town Development has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.