Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that China VAST Industrial Urban Development Company Limited (HKG:6166) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China VAST Industrial Urban Development

How Much Debt Does China VAST Industrial Urban Development Carry?

The chart below, which you can click on for greater detail, shows that China VAST Industrial Urban Development had CN¥6.29b in debt in December 2021; about the same as the year before. On the flip side, it has CN¥840.8m in cash leading to net debt of about CN¥5.45b.

How Strong Is China VAST Industrial Urban Development's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China VAST Industrial Urban Development had liabilities of CN¥4.58b due within 12 months and liabilities of CN¥3.87b due beyond that. Offsetting these obligations, it had cash of CN¥840.8m as well as receivables valued at CN¥452.6m due within 12 months. So it has liabilities totalling CN¥7.16b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥3.17b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, China VAST Industrial Urban Development would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

China VAST Industrial Urban Development has a rather high debt to EBITDA ratio of 10.5 which suggests a meaningful debt load. However, its interest coverage of 2.9 is reasonably strong, which is a good sign. Worse, China VAST Industrial Urban Development's EBIT was down 60% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China VAST Industrial Urban Development will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, China VAST Industrial Urban Development recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

On the face of it, China VAST Industrial Urban Development's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. Taking into account all the aforementioned factors, it looks like China VAST Industrial Urban Development has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for China VAST Industrial Urban Development (2 don't sit too well with us!) that you should be aware of before investing here.

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.