Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that China Overseas Property Holdings Limited (HKG:2669) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for China Overseas Property Holdings

How Much Debt Does China Overseas Property Holdings Carry?

As you can see below, at the end of June 2022, China Overseas Property Holdings had HK$449.8m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has HK$3.56b in cash, leading to a HK$3.11b net cash position.

How Strong Is China Overseas Property Holdings' Balance Sheet?

We can see from the most recent balance sheet that China Overseas Property Holdings had liabilities of HK$5.65b falling due within a year, and liabilities of HK$121.6m due beyond that. Offsetting these obligations, it had cash of HK$3.56b as well as receivables valued at HK$3.06b due within 12 months. So it can boast HK$838.3m more liquid assets than total liabilities.

This short term liquidity is a sign that China Overseas Property Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that China Overseas Property Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, China Overseas Property Holdings grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if China Overseas Property Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While China Overseas Property Holdings 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. In the last three years, China Overseas Property Holdings's free cash flow amounted to 44% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Overseas Property Holdings has net cash of HK$3.11b, as well as more liquid assets than liabilities. And we liked the look of last year's 36% year-on-year EBIT growth. So is China Overseas Property Holdings's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of China Overseas Property Holdings's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.