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.'  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 China Overseas Property Holdings Limited (HKG:2669) does use debt in its business.  But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price.  If things get really bad, the lenders can take control of the business.  However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders.  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.

How Much Debt Does China Overseas Property Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that China Overseas Property Holdings had HK$56.4m of debt in December 2023, down from HK$68.2m, one year before.    But on the other hand it also has HK$5.13b in cash, leading to a HK$5.07b net cash position.  

SEHK:2669 Debt to Equity History March 27th 2024

A Look At China Overseas Property Holdings' Liabilities

The latest balance sheet data shows that China Overseas Property Holdings had liabilities of HK$6.37b due within a year, and liabilities of HK$68.6m falling due after that.   Offsetting these obligations, it had cash of HK$5.13b as well as receivables valued at HK$3.03b due within 12 months.   So it actually has HK$1.73b more liquid assets than total liabilities.  

This short term liquidity is a sign that China Overseas Property Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched.    Simply put, the fact that China Overseas Property Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.  

The good news is that China Overseas Property Holdings has increased its EBIT by 7.7% over twelve months, which should ease any concerns about debt repayment.      When analysing debt levels, the balance sheet is the obvious place to start.  But ultimately the future profitability of the business will decide if China Overseas Property Holdings 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits.   While China Overseas Property Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance.    During the last three years, China Overseas Property Holdings produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect.  This free cash flow puts the company in a good position to pay down debt, when appropriate.  

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Overseas Property Holdings has net cash of HK$5.07b, as well as more liquid assets than liabilities.     The cherry on top was that in converted 77% of that EBIT to free cash flow, bringing in HK$1.8b.     So is China Overseas Property Holdings's debt a risk? It doesn't seem so to us.    There's no doubt that we learn most about debt from the balance sheet.  However, not all investment risk resides within the balance sheet - far from it.     We've identified 2 warning signs with China Overseas Property Holdings , and understanding them should be part of your investment process.  

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.