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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Beijing Urban Construction Design & Development Group Co., Limited (HKG:1599) makes use of 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Beijing Urban Construction Design & Development Group
What Is Beijing Urban Construction Design & Development Group's Debt?
As you can see below, at the end of December 2018, Beijing Urban Construction Design & Development Group had CN¥4.61b of debt, up from CN¥3.31b a year ago. Click the image for more detail. However, it also had CN¥3.89b in cash, and so its net debt is CN¥714.0m.
How Strong Is Beijing Urban Construction Design & Development Group's Balance Sheet?
According to the last reported balance sheet, Beijing Urban Construction Design & Development Group had liabilities of CN¥7.32b due within 12 months, and liabilities of CN¥4.50b due beyond 12 months. Offsetting this, it had CN¥3.89b in cash and CN¥5.88b in receivables that were due within 12 months. So it has liabilities totalling CN¥2.05b more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of CN¥2.49b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).