These 4 metrics indicate that Longfor Group Holdings (HKG: 960) is using debt extensively
Howard Marks put it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. It’s only natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. Above all, Longfor Group Holdings Limited (HKG: 960) carries the debt. But should shareholders be concerned about its use of debt?
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we look at debt levels, we first look at cash and debt levels, together.
Check out our latest analysis for Longfor Group Holdings
What is the net debt of Longfor Group Holdings?
As you can see below, at the end of June 2021, Longfor Group Holdings was in debt of CNN 210.0 billion, up from CNN 181.9 billion a year ago. Click on the image for more details. However, given that it has a cash reserve of CN 99.1 billion, its net debt is less, at around CN 110.9 billion.
How strong is Longfor Group Holdings’ balance sheet?
We can see from the most recent balance sheet that Longfor Group Holdings had CN 471.9 billion in liabilities due within one year and CN 200.9 billion in liabilities due beyond. On the other hand, he had CN 99.1 billion in cash and CN 107.9 billion in receivables due within one year. It therefore has liabilities totaling CN 465.9 billion more than its cash and short-term receivables combined.
This deficit casts a shadow over CN ¥ 186.1b society, like a colossus towering above mere mortals. We therefore believe that shareholders should monitor it closely. After all, Longfor Group Holdings would likely need a major recapitalization if it were to pay its creditors today.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we look at debt versus earnings with and without amortization expenses.
Longfor Group Holdings’ net debt is 2.7 times its EBITDA, which represents significant but still reasonable leverage. However, its interest coverage of 1k is very high, which suggests that interest charges on debt are currently quite low. Unfortunately, Longfor Group Holdings has seen its EBIT drop 4.3% in the past twelve months. If incomes continue to decline, managing that debt will be difficult, like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Longfor Group Holdings’ ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Longfor Group Holdings has actually generated more free cash flow than EBIT. This kind of cash conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
Whereas the level of total liabilities of Longfor Group Holdings makes us nervous. Both its interest coverage and the conversion of EBIT to free cash flow were encouraging signs. When we consider all the factors mentioned, it seems to us that Longfor Group Holdings is taking risks with its recourse to debt. While this debt may increase returns, we believe the company now has sufficient leverage. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. To this end, you should inquire about the 2 warning signs we spotted with Longfor Group Holdings (including 1 essential).
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.