Is Cofco Sugar HoldingLTD (SHSE:600737) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Cofco Sugar Holding CO.,LTD. (SHSE:600737) does carry debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Cofco Sugar HoldingLTD

How Much Debt Does Cofco Sugar HoldingLTD Carry?

As you can see below, Cofco Sugar HoldingLTD had CN¥2.62b of debt at September 2024, down from CN¥4.85b a year prior. However, because it has a cash reserve of CN¥2.46b, its net debt is less, at about CN¥165.0m.

How Healthy Is Cofco Sugar HoldingLTD's Balance Sheet?

According to the last reported balance sheet, Cofco Sugar HoldingLTD had liabilities of CN¥7.83b due within 12 months, and liabilities of CN¥272.9m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.46b as well as receivables valued at CN¥3.04b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.61b.

Of course, Cofco Sugar HoldingLTD has a market capitalization of CN¥20.9b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, Cofco Sugar HoldingLTD has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Cofco Sugar HoldingLTD has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.057 and EBIT of 21.3 times the interest expense. So relative to past earnings, the debt load seems trivial. On top of that, Cofco Sugar HoldingLTD grew its EBIT by 57% over the last twelve months, and that growth will make it easier to handle its debt. 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 Cofco Sugar HoldingLTD 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. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Cofco Sugar HoldingLTD created free cash flow amounting to 17% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Happily, Cofco Sugar HoldingLTD's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. When we consider the range of factors above, it looks like Cofco Sugar HoldingLTD is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Cofco Sugar HoldingLTD that you should be aware of before investing here.

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.