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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. We can see that Country Garden Holdings Company Limited (HKG:2007) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.
See our latest analysis for Country Garden Holdings
What Is Country Garden Holdings's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Country Garden Holdings had CN¥332.4b of debt, an increase on CN¥294.7b, over one year. On the flip side, it has CN¥223.4b in cash leading to net debt of about CN¥109.1b.
How Strong Is Country Garden Holdings's Balance Sheet?
The latest balance sheet data shows that Country Garden Holdings had liabilities of CN¥1.31t due within a year, and liabilities of CN¥248.0b falling due after that. On the other hand, it had cash of CN¥223.4b and CN¥303.4b worth of receivables due within a year. So it has liabilities totalling CN¥1.03t more than its cash and near-term receivables, combined.
This deficit casts a shadow over the CN¥206.3b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt After all, Country Garden Holdings would likely require a major re-capitalisation if it had to pay its creditors today.
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). 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).