The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Jujiang Construction Group Co., Ltd. (HKG:1459) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.
What Is Jujiang Construction Group's Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Jujiang Construction Group had debt of CN¥560.1m, up from CN¥466.7m in one year. However, it does have CN¥236.9m in cash offsetting this, leading to net debt of about CN¥323.2m.
How Healthy Is Jujiang Construction Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Jujiang Construction Group had liabilities of CN¥3.83b due within 12 months and liabilities of CN¥102.4m due beyond that. Offsetting this, it had CN¥236.9m in cash and CN¥4.21b in receivables that were due within 12 months. So it can boast CN¥519.1m more liquid assets than total liabilities.
This excess liquidity is a great indication that Jujiang Construction Group'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.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
With net debt sitting at just 1.1 times EBITDA, Jujiang Construction Group is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 7.2 times the interest expense over the last year. The good news is that Jujiang Construction Group has increased its EBIT by 7.7% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is Jujiang Construction Group'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Jujiang Construction Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Jujiang Construction Group's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its level of total liabilities is also very heartening. It looks Jujiang Construction Group has no trouble standing on its own two feet, and it has no reason to fear its lenders. To our minds it has a healthy happy balance sheet. Given Jujiang Construction Group 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.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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