Does CIMC Enric Holdings (HKG:3899) Have A Healthy Balance Sheet?

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 note that CIMC Enric Holdings Limited (HKG:3899) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

See our latest analysis for CIMC Enric Holdings

What Is CIMC Enric Holdings's Debt?

The chart below, which you can click on for greater detail, shows that CIMC Enric Holdings had CN¥963.4m in debt in December 2020; about the same as the year before. However, its balance sheet shows it holds CN¥2.65b in cash, so it actually has CN¥1.68b net cash.

A Look At CIMC Enric Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that CIMC Enric Holdings had liabilities of CN¥7.65b due within 12 months and liabilities of CN¥952.3m due beyond that. Offsetting this, it had CN¥2.65b in cash and CN¥3.49b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.47b.

CIMC Enric Holdings has a market capitalization of CN¥11.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, CIMC Enric Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact CIMC Enric Holdings's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 CIMC Enric Holdings 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. CIMC Enric Holdings 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. During the last three years, CIMC Enric Holdings produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While CIMC Enric Holdings does have more liabilities than liquid assets, it also has net cash of CN¥1.68b. The cherry on top was that in converted 75% of that EBIT to free cash flow, bringing in CN¥573m. So we don't have any problem with CIMC Enric Holdings's use of debt. 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. For instance, we've identified 2 warning signs for CIMC Enric Holdings that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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