China Communications Services (HKG:552) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that China Communications Services Corporation Limited (HKG:552) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

See our latest analysis for China Communications Services

What Is China Communications Services's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 China Communications Services had debt of CN¥850.0m, up from CN¥764.9m in one year. But on the other hand it also has CN¥19.5b in cash, leading to a CN¥18.6b net cash position.

A Look At China Communications Services' Liabilities

We can see from the most recent balance sheet that China Communications Services had liabilities of CN¥64.2b falling due within a year, and liabilities of CN¥2.30b due beyond that. On the other hand, it had cash of CN¥19.5b and CN¥47.8b worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

This short term liquidity is a sign that China Communications Services could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, China Communications Services boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that China Communications Services's load is not too heavy, because its EBIT was down 44% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 China Communications Services 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. China Communications Services 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 Communications Services actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Communications Services has CN¥18.6b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 108% of that EBIT to free cash flow, bringing in CN¥2.7b. So we are not troubled with China Communications Services'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. For instance, we've identified 1 warning sign for China Communications Services that 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.