Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Mostly, China Dongxiang (Group) Co., Ltd. (HKG: 3818) carries a debt. But the most important question is: what risk does this debt create?
When is debt a problem?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business 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 flow and debt together.
See our latest analysis for China Dongxiang (Group)
What is the net debt of China Dongxiang (Group)?
The image below, which you can click for more details, shows China Dongxiang (Group) owed CN 126.6 million in debt at the end of March 2021, a reduction from CN’s 246.3 million on a year. However, his balance sheet shows he has CN 5.38 billion in cash, so he actually has net cash of CN 5.25 billion.
How strong is China Dongxiang (Group) ‘s balance sheet?
We can see from the most recent balance sheet that China Dongxiang (Group) had liabilities of CNN 721.3 million maturing within one year, and CN liabilities of CN 380.6 million beyond. In return he had CN 5.38 billion in cash and CN 701.5 million in receivables due within 12 months. So, it can boast of having more CN ¥ 4.98b of liquid assets than total Liabilities.
This abundant liquidity means that the balance sheet of China Dongxiang (Group) is as solid as a giant sequoia. From this point of view, lenders should feel as secure as the beloved of a black belt karate master. Put simply, the fact that China Dongxiang (Group) has more cash than debt is arguably a good indication that it can safely manage its debt.
Better yet, China Dongxiang (Group) increased its EBIT by 293% last year, which is an impressive improvement. This boost will make it even easier to pay down debt in the future. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future earnings, more than anything, that will determine China Dongxiang (Group) ‘s ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. China Dongxiang (Group) may have net cash on the balance sheet, but it is still interesting to examine how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence the both his need, and his ability to manage debt. In the past three years, China Dongxiang (Group) recorded total negative free cash flow. Debt is typically more expensive and almost always riskier in the hands of a business with negative free cash flow. Shareholders should hope for improvement.
In summary
While we sympathize with investors who find debt worrying, you should keep in mind that China Dongxiang (Group) has net cash of 5.25 billion yuan, as well as more liquid assets than liabilities. And we liked the appearance of the 293% EBIT growth last year. We therefore do not believe that the use of debt by China Dongxiang (Group) is risky. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 4 warning signs for China Dongxiang (Group) (2 make us uncomfortable!) Which you should be aware of before investing here.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash-flow net-growth stocks.
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