Yahoo Finance We Think CITIC (HKG:267) Is Taking Some Risk With Its Debt
Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, CITIC Limited (HKG:267) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for CITIC
What Is CITIC's Debt?
As you can see below, CITIC had HK$1.49t of debt, at December 2019, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds HK$1.57t in cash, so it actually has HK$86.1b net cash.
How Healthy Is CITIC's Balance Sheet?
According to the last reported balance sheet, CITIC had liabilities of HK$4.29t due within 12 months, and liabilities of HK$3.11t due beyond 12 months. Offsetting this, it had HK$1.57t in cash and HK$4.44t in receivables that were due within 12 months. So it has liabilities totalling HK$1.39t more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the HK$202.2b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, CITIC would probably need a major re-capitalization if its creditors were to demand repayment. CITIC boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.
We saw CITIC grow its EBIT by 3.7% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine CITIC's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While CITIC 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, CITIC produced sturdy free cash flow equating to 50% 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
Although CITIC's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$86.1b. Despite its cash we think that CITIC seems to struggle to handle its total liabilities, so we are wary of the stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that CITIC is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. 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. Thank you for reading.
