Here’s why Hao Tian International Construction Investment Group (HKG:1341) has significant debt

Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing is not price volatility, but whether you’ll suffer a loss. permanent capital”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Above all, Hao Tian International Construction Investment Group Limited (HKG:1341) is in debt. But should shareholders worry about its use of debt?

What risk does debt carry?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we look at debt levels, we first consider cash and debt levels, together.

Check out our latest analysis for Hao Tian International Construction Investment Group

How much debt does Hao Tian International Construction Investment Group have?

As you can see below, Hao Tian International Construction Investment Group had HK$1.10 billion in debt as of March 2022, roughly the same as the previous year. You can click on the graph for more details. However, he has HK$335.0 million to offset this, resulting in a net debt of approximately HK$762.0 million.

SEHK: 1341 Debt to Equity History August 15, 2022

How healthy is Hao Tian International Construction Investment Group’s balance sheet?

The latest balance sheet data shows that Hao Tian International Construction Investment Group had liabilities of HK$597.0 million due within one year, and liabilities of HK$701.0 million coming to deadline thereafter. In return, it had HK$335.0 million in cash and HK$610.0 million in receivables due within 12 months. It therefore has liabilities totaling HK$353.0 million more than its cash and short-term receivables, combined.

Of course, Hao Tian International Construction Investment Group has a market capitalization of HK$2.31 billion, so those liabilities are probably manageable. That said, it is clear that we must continue to monitor its record, lest it deteriorate.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.

A low interest coverage of 1.2x and an extremely high net debt to EBITDA ratio of 15.9 shook our confidence in Hao Tian International Construction Investment Group like a punch in the gut. The debt burden here is considerable. Worse still, Hao Tian International Construction Investment Group’s EBIT was down 54% from a year ago. If the profits continue like this in the long term, there is an unimaginable chance of repaying this debt. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since Hao Tian International Construction Investment Group will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past two years, Hao Tian International Construction Investment Group has actually produced more free cash flow than EBIT. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our point of view

Hao Tian International Construction Investment Group’s EBIT growth rate and interest coverage are certainly weighing on it, in our view. But the good news is that it seems to be able to easily convert EBIT to free cash flow. Considering the above factors, we believe that Hao Tian International Construction Investment Group’s debt poses certain risks to the business. While this debt may increase returns, we believe the company now has sufficient leverage. 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 outside of the balance sheet. Example: we have identified 2 warning signs for Hao Tian International Construction Investment Group you need to be aware of, and 1 of them can’t be ignored.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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