Is Midea Real Estate Holding (HKG:3990) A Risky Investment?

Howard Marks put it nicely when he said, instead of worrying about stock price volatility, “The possibility of permanent loss is the risk I’m worried about … and every practical investor I know takes to worry.” So it might be obvious that you need to consider debt when thinking about how risky a particular stock is, as too much debt can bring a company down. As with many other companies Midea Real Estate Holding Limited (HKG: 3990) uses debt. But does this debt worry shareholders?

Why does debt pose a risk?

Debt supports a company until the company has difficulty paying it, either with new capital or with free cash flow. When things get really bad, lenders can take control of the business. However, a more common (but still more painful) scenario is that it needs to raise new equity at a low price, permanently diluting shareholders. However, in replacing the dilution, debt can be an extremely good tool for companies that need capital to invest in high-yielding growth. When we think about using a company’s debt, let’s first look at cash and debt together.

Check out our latest analysis for Midea Real Estate Holding

How much debt does Midea Real Estate Holding have?

As you can see below, Midea Real Estate Holding had $ 57.1bn in debt in June 2021. You can click the chart for more details. However, this is offset by CN ¥ 24.4 billion in cash, resulting in a net debt of approximately CN 32.7 billion.

SEHK: 3990 Debt to Equity History August 27, 2021

A look at the liabilities of Midea Real Estate Holding

The latest balance sheet data shows that Midea Real Estate Holding had liabilities of CN199.1 billion within one year and CNY47.7 billion due in liabilities thereafter. To offset these commitments, it had cash on hand of CN 24.4 billion and claims of CN 41.4 billion due within 12 months. So she has liabilities of CN181.0 billion more than her cash and short-term receivables combined.

The shortage here weighs heavily on the CN ¥ 15.5b company itself, as if a child were struggling under the weight of a huge backpack full of books, sports equipment, and a trumpet. Therefore, we believe that shareholders should definitely watch this closely. Ultimately, Midea Real Estate Holding would need a major recapitalization if its creditors were to demand repayment.

We measure a company’s debt burden in relation to its profitability by looking at net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily earnings before interest and taxes (EBIT) cover its interest costs (Interest coverage). Therefore, we consider debt relative to earnings both with and without depreciation.

Midea Real Estate Holding’s net debt is 3.9 times its EBITDA, which is a sizable but still reasonable leverage. But its EBIT was about a thousand times its interest expense, which means the company isn’t paying really high costs to maintain that level of debt. Even if the low costs turn out to be unsustainable, that’s a good sign. Unfortunately, Midea Real Estate Holding’s EBIT even fell by 4.8% last year. As earnings continue to decline, this debt becomes difficult to manage like hot soup on a unicycle. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the future profitability of the business will determine whether Midea Real Estate Holding can strengthen its balance sheet over time. So, if you want to know what the professionals are thinking, this free analyst earnings forecast report might be of interest.

After all, a company can only pay off debts with cold money, not book profits. So the logical step is to look at the portion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Midea Real Estate Holding has seen significant negative free cash flow overall. While investors no doubt expect this situation to reverse in due course, it clearly means that using debt is riskier.

Our view

At first glance, Midea Real Estate Holding’s conversion of EBIT to free cash flow on the stock made us hesitant, and the level of total debt was no more tempting than that one empty restaurant on the busiest night of the year. But on the positive side, interest coverage is a good sign and makes us more optimistic. Overall, Midea Real Estate Holding’s balance sheet seems to us to be a real risk to the business. So we are almost as careful with this stock as a hungry kitten falling into its owner’s fish pond: once bitten, twice shy, as they say. Undoubtedly, we learn most about balance sheet debt. However, not all of the investment risk is on the balance sheet – on the contrary. We have identified 4 warning signs with Midea Real Estate Holding (at least 1 which is a little worrying) and understanding them should be part of your investment process.

After all that, if you’re more interested in a fast-growing company with a rock-solid balance sheet, then immediately check out our list of Net Cash Growth Stocks.

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This article from Simply Wall St is of a general nature. We only provide comments based on historical data and analyst projections using an unbiased methodology, and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. Our goal is to provide you with long-term, focused analysis based on fundamentals. Note that our analysis may not take into account the latest company announcements or quality material, which may be sensitive to the price. Simply Wall St has no position in the stocks mentioned.
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