Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Hangzhou Binjiang Real Estate Group Co.,Ltd (SZSE:002244) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

What Is Hangzhou Binjiang Real Estate GroupLtd's Net Debt?

As you can see below, Hangzhou Binjiang Real Estate GroupLtd had CN¥60.6b of debt at September 2024, down from CN¥66.5b a year prior. On the flip side, it has CN¥29.3b in cash leading to net debt of about CN¥31.2b.

How Strong Is Hangzhou Binjiang Real Estate GroupLtd's Balance Sheet?

According to the last reported balance sheet, Hangzhou Binjiang Real Estate GroupLtd had liabilities of CN¥189.7b due within 12 months, and liabilities of CN¥29.8b due beyond 12 months. Offsetting this, it had CN¥29.3b in cash and CN¥34.6b in receivables that were due within 12 months. So it has liabilities totalling CN¥155.6b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥27.6b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Hangzhou Binjiang Real Estate GroupLtd would probably need a major re-capitalization if its creditors were to demand repayment.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely Hangzhou Binjiang Real Estate GroupLtd has a sky high EBITDA ratio of 11.9, implying high debt, but a strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Shareholders should be aware that Hangzhou Binjiang Real Estate GroupLtd's EBIT was down 71% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hangzhou Binjiang Real Estate GroupLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Hangzhou Binjiang Real Estate GroupLtd actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

To be frank both Hangzhou Binjiang Real Estate GroupLtd's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We're quite clear that we consider Hangzhou Binjiang Real Estate GroupLtd to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Hangzhou Binjiang Real Estate GroupLtd is showing 3 warning signs in our investment analysis , and 1 of those is concerning...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.