Luzhou LaojiaoLtd (SZSE:000568) Could Easily Take On More 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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Luzhou Laojiao Co.,Ltd (SZSE:000568) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Luzhou LaojiaoLtd

What Is Luzhou LaojiaoLtd's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Luzhou LaojiaoLtd had debt of CN¥13.5b, up from CN¥12.1b in one year. However, it does have CN¥33.4b in cash offsetting this, leading to net cash of CN¥19.9b.

A Look At Luzhou LaojiaoLtd's Liabilities

The latest balance sheet data shows that Luzhou LaojiaoLtd had liabilities of CN¥10.1b due within a year, and liabilities of CN¥12.2b falling due after that. Offsetting this, it had CN¥33.4b in cash and CN¥5.38b in receivables that were due within 12 months. So it actually has CN¥16.5b more liquid assets than total liabilities.

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

Another good sign is that Luzhou LaojiaoLtd has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Luzhou LaojiaoLtd 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. While Luzhou LaojiaoLtd 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 most recent three years, Luzhou LaojiaoLtd recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Luzhou LaojiaoLtd has CN¥19.9b in net cash and a decent-looking balance sheet. And we liked the look of last year's 28% year-on-year EBIT growth. So we don't think Luzhou LaojiaoLtd's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Luzhou LaojiaoLtd .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.