Is VATS Liquor Chain Store Management (SZSE:300755) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 VATS Liquor Chain Store Management Joint Stock Co., Ltd. (SZSE:300755) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for VATS Liquor Chain Store Management

How Much Debt Does VATS Liquor Chain Store Management Carry?

As you can see below, VATS Liquor Chain Store Management had CN¥1.41b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥1.01b in cash offsetting this, leading to net debt of about CN¥404.5m.

How Strong Is VATS Liquor Chain Store Management's Balance Sheet?

We can see from the most recent balance sheet that VATS Liquor Chain Store Management had liabilities of CN¥3.07b falling due within a year, and liabilities of CN¥59.1m due beyond that. Offsetting this, it had CN¥1.01b in cash and CN¥410.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥1.71b more than its cash and near-term receivables, combined.

VATS Liquor Chain Store Management has a market capitalization of CN¥8.42b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

We'd say that VATS Liquor Chain Store Management's moderate net debt to EBITDA ratio ( being 1.7), indicates prudence when it comes to debt. And its commanding EBIT of 10.3 times its interest expense, implies the debt load is as light as a peacock feather. Fortunately, VATS Liquor Chain Store Management grew its EBIT by 4.2% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if VATS Liquor Chain Store Management 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, VATS Liquor Chain Store Management burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

VATS Liquor Chain Store Management's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its interest cover was refreshing. Looking at all the angles mentioned above, it does seem to us that VATS Liquor Chain Store Management is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with VATS Liquor Chain Store Management (including 1 which is potentially serious) .

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.