Is Midea Group (SZSE:000333) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Midea Group Co., Ltd. (SZSE:000333) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Midea Group

How Much Debt Does Midea Group Carry?

You can click the graphic below for the historical numbers, but it shows that Midea Group had CN¥67.5b of debt in March 2024, down from CN¥74.9b, one year before. But on the other hand it also has CN¥97.9b in cash, leading to a CN¥30.5b net cash position.

How Strong Is Midea Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Midea Group had liabilities of CN¥254.0b due within 12 months and liabilities of CN¥60.1b due beyond that. Offsetting these obligations, it had cash of CN¥97.9b as well as receivables valued at CN¥84.1b due within 12 months. So it has liabilities totalling CN¥132.0b more than its cash and near-term receivables, combined.

Midea Group has a very large market capitalization of CN¥428.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Midea Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Midea Group has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Midea Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Midea Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Midea Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Midea Group does have more liabilities than liquid assets, it also has net cash of CN¥30.5b. And it impressed us with free cash flow of CN¥56b, being 119% of its EBIT. So we don't think Midea Group's use of debt is risky. Given Midea Group has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com