We Think Chacha Food Company (SZSE:002557) Can Manage Its Debt With Ease

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Chacha Food Company, Limited (SZSE:002557) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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.

Check out our latest analysis for Chacha Food Company

What Is Chacha Food Company's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Chacha Food Company had CN¥2.36b of debt, an increase on CN¥1.97b, over one year. However, its balance sheet shows it holds CN¥6.00b in cash, so it actually has CN¥3.64b net cash.

A Look At Chacha Food Company's Liabilities

Zooming in on the latest balance sheet data, we can see that Chacha Food Company had liabilities of CN¥2.13b due within 12 months and liabilities of CN¥1.47b due beyond that. Offsetting this, it had CN¥6.00b in cash and CN¥317.7m in receivables that were due within 12 months. So it can boast CN¥2.72b more liquid assets than total liabilities.

This surplus suggests that Chacha Food Company is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Chacha Food Company boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Chacha Food Company grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Chacha Food Company can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Chacha Food Company may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Chacha Food Company recorded free cash flow worth 79% 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 we empathize with investors who find debt concerning, you should keep in mind that Chacha Food Company has net cash of CN¥3.64b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥668m, being 79% of its EBIT. So we don't think Chacha Food Company'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. For instance, we've identified 1 warning sign for Chacha Food Company that you should be aware of.

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.