Legendary fund manager Li Lu (who Charlie Munger supported) once said, âThe biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. It is 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, Vanke Overseas Investment Holding Company Limited (HKG: 1036) carries a debt. But the most important question is: what risk does this debt create?
When Is Debt a Problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free 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 costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies 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 flow and debt together.
Check out our latest review for Vanke Overseas Investment Holding
What is the debt of Vanke Overseas Investment Holding?
The image below, which you can click for more details, shows that in June 2021, Vanke Overseas Investment Holding was in debt of HK $ 1.24 billion, compared to HK $ 1.12 billion in one. year. On the other hand, he has HK $ 659.7million in cash, resulting in net debt of around HK $ 577.1million.
How strong is Vanke Overseas Investment Holding’s balance sheet?
According to the latest published balance sheet, Vanke Overseas Investment Holding had liabilities of HK $ 1.07 billion due within 12 months, and liabilities of HK $ 556.0 million due beyond 12 months. In compensation for these obligations, it had cash of HK $ 659.7 million as well as receivables valued at HK $ 72.3 million due within 12 months. It therefore has liabilities totaling HK $ 891.2 million more than its cash and short-term receivables combined.
This is a mountain of leverage compared to its market cap of HK $ 954.3 million. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). 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).
Vanke Overseas Investment Holding’s net debt / EBITDA ratio of around 1.9 suggests only moderate use of debt. And its imposing EBIT of 11.6 times its interest costs, means the debt load is as light as a peacock feather. One way Vanke Overseas Investment Holding could beat its debt would be to stop borrowing more but continue to increase its EBIT by around 16%, as it did last year. The balance sheet is clearly the area you need to focus on when analyzing debt. But you can’t look at debt in isolation; since Vanke Overseas Investment Holding will need income to repay this debt. So if you want to know more about its profits, it may be worth checking out this chart of its long term profit trend.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Vanke Overseas Investment Holding has recorded free cash flow of 47% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.
Our point of view
Regarding the balance sheet, the most remarkable positive point for Vanke Overseas Investment Holding was the fact that it seems able to cover its interest charges with its EBIT with confidence. But the other factors we noted above weren’t so encouraging. For example, it looks like he has to struggle a bit to manage his total liabilities. When we consider all of the factors mentioned above, we feel a little cautious about the use of debt by Vanke Overseas Investment Holding. While debt has its advantage in terms of potential higher returns, we believe shareholders should definitely consider how leverage levels might make the stock riskier. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Vanke Overseas Investment Holding you should know.
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 documents. Simply Wall St has no position in any of the stocks mentioned.
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