Is China United Network Communications (SHSE:600050) Using Too Much Debt?

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.' 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 note that China United Network Communications Limited (SHSE:600050) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for China United Network Communications

What Is China United Network Communications's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 China United Network Communications had CN¥16.1b of debt, an increase on CN¥14.3b, over one year. But on the other hand it also has CN¥76.8b in cash, leading to a CN¥60.7b net cash position.

How Strong Is China United Network Communications' Balance Sheet?

The latest balance sheet data shows that China United Network Communications had liabilities of CN¥263.2b due within a year, and liabilities of CN¥39.0b falling due after that. Offsetting this, it had CN¥76.8b in cash and CN¥67.4b in receivables that were due within 12 months. So its liabilities total CN¥157.9b more than the combination of its cash and short-term receivables.

This is a mountain of leverage even relative to its gargantuan market capitalization of CN¥183.5b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, China United Network Communications boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that China United Network Communications saw its EBIT decline by 5.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine China United Network Communications's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. China United Network Communications 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. Happily for any shareholders, China United Network Communications actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although China United Network Communications's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥60.7b. The cherry on top was that in converted 157% of that EBIT to free cash flow, bringing in CN¥17b. So we are not troubled with China United Network Communications's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for China United Network Communications you should be aware of.

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.