Is COFCO Capital Holdings (SZSE:002423) Using Too Much Debt?

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.' 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 COFCO Capital Holdings Co., Ltd. (SZSE:002423) does use debt in its business. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for COFCO Capital Holdings

How Much Debt Does COFCO Capital Holdings Carry?

As you can see below, COFCO Capital Holdings had CN¥10.8b of debt at June 2024, down from CN¥14.0b a year prior. However, it does have CN¥35.0b in cash offsetting this, leading to net cash of CN¥24.3b.

How Healthy Is COFCO Capital Holdings' Balance Sheet?

We can see from the most recent balance sheet that COFCO Capital Holdings had liabilities of CN¥42.0b falling due within a year, and liabilities of CN¥72.2b due beyond that. On the other hand, it had cash of CN¥35.0b and CN¥1.76b worth of receivables due within a year. So it has liabilities totalling CN¥77.4b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥40.2b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, COFCO Capital Holdings would likely require a major re-capitalisation if it had to pay its creditors today. Given that COFCO Capital Holdings has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

One way COFCO Capital Holdings could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 14%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But it is COFCO Capital Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While COFCO Capital Holdings 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. Over the last three years, COFCO Capital Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While COFCO Capital Holdings does have more liabilities than liquid assets, it also has net cash of CN¥24.3b. The cherry on top was that in converted 324% of that EBIT to free cash flow, bringing in CN¥8.6b. So we are not troubled with COFCO Capital Holdings's debt use. 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. Be aware that COFCO Capital Holdings is showing 1 warning sign in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.