Is Redsun Properties Group (HKG:1996) using too much debt?
Warren Buffett said: “Volatility is far from synonymous with risk. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We note that Redsun Properties Group Limited (HKG:1996) has a debt on its balance sheet. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
See our latest analysis for Redsun Properties Group
What is Redsun Properties Group’s net debt?
You can click on the graph below for historical figures, but it shows that in December 2021, Redsun Properties Group had debt of 34.1 billion Canadian yen, an increase from 32.3 billion Canadian yen , over one year. However, he also had 16.6 billion Canadian yen in cash, so his net debt is 17.6 billion domestic yen.
How strong is Redsun Properties Group’s balance sheet?
The latest balance sheet data shows that Redsun Properties Group had liabilities of 74.2 billion yen maturing within one year, and liabilities of 26.8 billion yen maturing thereafter. On the other hand, it had a cash position of 16.6 billion Canadian yen and 14.8 billion national yen of receivables due within the year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 69.6 billion Canadian yen.
This deficit casts a shadow over the CN¥7.24b society, like a colossus towering above mere mortals. So we definitely think shareholders need to watch this one closely. Ultimately, Redsun Properties Group would likely need a major recapitalization if its creditors were to demand repayment.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
With a net debt to EBITDA ratio of 5.4, it’s fair to say that Redsun Properties Group has significant debt. However, its interest coverage of 3.3 is reasonably strong, which is a good sign. On a lighter note, note that Redsun Properties Group has increased its EBIT by 23% over the past year. If sustained, this growth should cause this debt to evaporate like scarce drinking water during an abnormally hot summer. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Redsun Properties Group’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Redsun Properties Group has experienced substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of this situation in due course, this clearly means that its use of debt is more risky.
Our point of view
To be frank, Redsun Properties Group’s conversion of EBIT to free cash flow and its track record of keeping its total liabilities under control makes us rather uncomfortable with its level of leverage. But at least it’s decent enough to increase its EBIT; it’s encouraging. Overall, it seems to us that the balance sheet of Redsun Properties Group is very much a risk for the company. We are therefore almost as wary of this stock as a hungry kitten of falling into its owner’s fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. To do this, you need to find out about the 3 warning signs we spotted with Redsun Properties Group (including 1 that should not be ignored).
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.