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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, China Communications Services Corporation Limited (HKG:552) does carry debt. But the more important question is: how much risk is that debt creating?

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When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is China Communications Services's Debt?

As you can see below, China Communications Services had CN¥706.2m of debt at December 2024, down from CN¥861.1m a year prior. However, its balance sheet shows it holds CN¥25.9b in cash, so it actually has CN¥25.2b net cash.

How Strong Is China Communications Services' Balance Sheet?

The latest balance sheet data shows that China Communications Services had liabilities of CN¥88.0b due within a year, and liabilities of CN¥2.05b falling due after that. Offsetting this, it had CN¥25.9b in cash and CN¥69.7b in receivables that were due within 12 months. So it actually has CN¥5.58b more liquid assets than total liabilities.

This surplus suggests that China Communications Services is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues 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.

Check out our latest analysis for China Communications Services

Fortunately, China Communications Services grew its EBIT by 7.8% in the last year, making that debt load look even more manageable. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. 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 conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Communications Services has CN¥25.2b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥5.1b, being 200% of its EBIT. So we don't think China Communications Services's use of debt is risky. 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.

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.