Stock Analysis

China Communications Services (HKG:552) Seems To Use Debt Rather Sparingly

SEHK:552
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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 China Communications Services Corporation Limited (HKG:552) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for China Communications Services

How Much Debt Does China Communications Services Carry?

The image below, which you can click on for greater detail, shows that at June 2021 China Communications Services had debt of CN¥764.9m, up from CN¥623.3m in one year. But on the other hand it also has CN¥23.2b in cash, leading to a CN¥22.4b net cash position.

debt-equity-history-analysis
SEHK:552 Debt to Equity History September 27th 2021

How Strong Is China Communications Services' Balance Sheet?

We can see from the most recent balance sheet that China Communications Services had liabilities of CN¥58.3b falling due within a year, and liabilities of CN¥2.49b due beyond that. On the other hand, it had cash of CN¥23.2b and CN¥43.1b worth of receivables due within a year. So it actually has CN¥5.46b more liquid assets than total liabilities.

This excess liquidity suggests that China Communications Services is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that China Communications Services has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that China Communications Services has boosted its EBIT by 34%, thus reducing the spectre of future debt repayments. 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 Communications Services'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China Communications Services 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. During the last three years, China Communications Services generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that China Communications Services has net cash of CN¥22.4b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.0b, being 85% of its EBIT. The bottom line is that we do not find China Communications Services's debt levels at all concerning. When analysing debt levels, the balance sheet is the obvious place to start. 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.

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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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.
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