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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that CITIC Limited (HKG:267) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
Check out our latest analysis for CITIC
How Much Debt Does CITIC Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2018 CITIC had HK$1.51t of debt, an increase on HK$1.34t, over one year. On the flip side, it has HK$1.41t in cash leading to net debt of about HK$91.3b.
How Strong Is CITIC's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that CITIC had liabilities of HK$3.79t due within 12 months and liabilities of HK$3.06t due beyond that. On the other hand, it had cash of HK$1.41t and HK$4.09t worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$1.34t.
This deficit casts a shadow over the HK$263.3b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt After all, CITIC would likely require a major re-capitalisation if it had to pay its creditors today.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Given net debt is only 0.35 times EBITDA, it is initially surprising to see that CITIC's EBIT has low interest coverage of 1.5 times. So one way or the other, it's clear the debt levels are not trivial. If CITIC can keep growing EBIT at last year's rate of 14% over the last year, then it will find its debt load easier to manage. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if CITIC can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.