LVGEM (China) Real Estate Investment (HKG:95) Use Of Debt Could Be Considered Risky
Warren Buffett famously said, “Volatility is far from synonymous with risk.” So it seems that the smart money knows that debt – which is usually associated with bankruptcies – is a very important factor in assessing how risky a business is. Important is, LVGEM (China) Real Estate Investment Company Limited (HKG: 95) is in debt. But should shareholders be concerned about the use of debt?
Why is debt at risk?
Debt is a tool to help businesses grow. However, when a company is unable to pay off its lenders, it is at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While this isn’t all that common, we often see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. The benefit of debt, of course, is that it is often cheap capital, especially when it replaces dilution in a company that is able to reinvest with high returns. When we examine leverage, we first look at both cash and leverage together.
Check out our latest analysis for LVGEM (China) Real Estate Investment
How much debt does LVGEM (China) real estate investment owe?
As you can see below, LVGEM (China) Real Estate Investment had debt of CNY 30.7 billion at the end of December 2020, compared to CNY 26.0 billion the previous year. Click the picture for more details. However, it also had CNY 5.43 billion in cash, so its net debt is CNY 25.2 billion.
SEHK: 95 debts to equity April 8, 2021
How strong is the balance sheet of LVGEM (China) Real Estate Investment?
The latest balance sheet data shows that LVGEM (China) Real Estate Investment matured within one year of liabilities of CNY 15.9 billion and thereafter liabilities of CNY 30.5 billion. On the flip side, it had CNY 5.43 billion in cash and CNY 120.6 million in receivables due within one year. So liabilities are CNY 40.8 billion more than the combination of cash and short-term receivables.
The shortage here weighs heavily on the company itself, at CNY 9.17 billion, like a child struggling under the weight of a huge backpack full of books, sports equipment and a trumpet. So there is no doubt that we would be closely monitoring the balance sheet. Ultimately, LVGEM (China) Real Estate Investment would likely need significant recapitalization if its creditors demanded 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 interest expenses (interest coverage ). In this way we consider both the absolute quantum of debt and the interest rates paid on it.
1.5 times weak interest coverage and a disruptively high ratio of net debt to EBITDA of 12.0 weighed on our confidence in LVGEM (China) Real Estate Investment like a double blow. The debt burden is considerable here. Worse still, LVGEM (China) Real Estate Investment’s EBIT fell 46% last year. If profits continue to follow this path, paying off that debt burden will be more difficult than convincing us to run a marathon in the rain. There is no doubt that we learn the most about debt from the balance sheet. Above all, future profits will determine LVGEM (China) Real Estate Investment’s ability to keep a healthy balance sheet in the future. So if you want to see what the professionals are thinking, this free analyst earnings forecast report might be of interest.
While the tax man may like book profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, LVGEM (China) Real Estate Investment recorded free cash flow of 47% of EBIT, which is weaker than expected. This poor cash conversion makes it difficult to deal with debt.
At first glance, LVGEM (China) Real Estate Investment’s EBIT growth rate made the stock look tentative, and the level of total debt was no more enticing than that one empty restaurant on the busiest night of the year. But at least converting EBIT to free cash flow isn’t that bad. With all of the above in mind, it looks like LVGEM (China) Real Estate Investment has too much debt. While some investors love this type of risky game, it is certainly not our cup of tea. The balance sheet is clearly the area to focus on when analyzing debt. However, not all of the investment risk is on the balance sheet – far from it. For example, LVGEM (China) has Real Estate Investment 3 warning signs (and 2 which are a little worrying) We think you should know about this.
After all that, if you’re more interested in a fast-growing company with a solid balance sheet, be sure to check out our list of net cash growth stocks right now.
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