Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies CITIC Resources Holdings Limited (HKG:1205) makes use of debt. But the more important question is: how much risk is that debt creating?
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. If things get really bad, the lenders can take control of the business. 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.
How Much Debt Does CITIC Resources Holdings Carry?
As you can see below, CITIC Resources Holdings had HK$5.58b of debt at June 2019, down from HK$6.76b a year prior. However, it does have HK$2.05b in cash offsetting this, leading to net debt of about HK$3.53b.
How Healthy Is CITIC Resources Holdings's Balance Sheet?
According to the last reported balance sheet, CITIC Resources Holdings had liabilities of HK$2.71b due within 12 months, and liabilities of HK$4.41b due beyond 12 months. Offsetting these obligations, it had cash of HK$2.05b as well as receivables valued at HK$444.6m due within 12 months. So it has liabilities totalling HK$4.63b more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's HK$3.85b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But it is CITIC Resources Holdings'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.
Over 12 months, CITIC Resources Holdings made a loss at the EBIT level, and saw its revenue drop to HK$4.1b, which is a fall of 2.5%. We would much prefer see growth.
Over the last twelve months CITIC Resources Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost HK$11m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. But on the bright side the company actually produced a statutory profit of HK$738m and free cash flow of HK$681m. So one might argue that there's still a chance it can get things on the right track. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how CITIC Resources Holdings's profit, revenue, and operating cashflow have changed over the last few years.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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