Chow Tai Seng Jewellery (SZSE:002867) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Chow Tai Seng Jewellery Co., Ltd. (SZSE:002867) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Chow Tai Seng Jewellery

What Is Chow Tai Seng Jewellery's Net Debt?

As you can see below, at the end of March 2024, Chow Tai Seng Jewellery had CN¥881.8m of debt, up from CN¥418.3m a year ago. Click the image for more detail. But it also has CN¥1.88b in cash to offset that, meaning it has CN¥999.6m net cash.

How Healthy Is Chow Tai Seng Jewellery's Balance Sheet?

We can see from the most recent balance sheet that Chow Tai Seng Jewellery had liabilities of CN¥2.33b falling due within a year, and liabilities of CN¥56.4m due beyond that. On the other hand, it had cash of CN¥1.88b and CN¥1.10b worth of receivables due within a year. So it actually has CN¥593.2m more liquid assets than total liabilities.

This surplus suggests that Chow Tai Seng Jewellery has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Chow Tai Seng Jewellery boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Chow Tai Seng Jewellery grew its EBIT at 15% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chow Tai Seng Jewellery's ability to maintain a healthy balance sheet going forward. 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 Chow Tai Seng Jewellery 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. Looking at the most recent three years, Chow Tai Seng Jewellery recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Chow Tai Seng Jewellery has CN¥999.6m in net cash and a decent-looking balance sheet. And it also grew its EBIT by 15% over the last year. So is Chow Tai Seng Jewellery's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Chow Tai Seng Jewellery has 2 warning signs (and 1 which is significant) we think you should know about.

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.