Is Hefei Department Store GroupLtd (SZSE:000417) 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.' 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 can see that Hefei Department Store Group Co.,Ltd (SZSE:000417) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Hefei Department Store GroupLtd

How Much Debt Does Hefei Department Store GroupLtd Carry?

As you can see below, Hefei Department Store GroupLtd had CN¥790.0m of debt at September 2024, down from CN¥1.34b a year prior. However, it does have CN¥1.42b in cash offsetting this, leading to net cash of CN¥628.6m.

How Strong Is Hefei Department Store GroupLtd's Balance Sheet?

The latest balance sheet data shows that Hefei Department Store GroupLtd had liabilities of CN¥5.49b due within a year, and liabilities of CN¥1.40b falling due after that. Offsetting this, it had CN¥1.42b in cash and CN¥350.7m in receivables that were due within 12 months. So its liabilities total CN¥5.13b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥4.80b, we think shareholders really should watch Hefei Department Store GroupLtd's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Hefei Department Store GroupLtd boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Also positive, Hefei Department Store GroupLtd grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. 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 Hefei Department Store GroupLtd 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 Hefei Department Store GroupLtd 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, Hefei Department Store GroupLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While Hefei Department Store GroupLtd does have more liabilities than liquid assets, it also has net cash of CN¥628.6m. And it impressed us with free cash flow of CN¥33m, being 104% of its EBIT. So we are not troubled with Hefei Department Store GroupLtd's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Hefei Department Store GroupLtd has 3 warning signs we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.