Is China Communications Services (HKG:552) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that China Communications Services Corporation Limited (HKG:552) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 China Communications Services had CN¥704.4m of debt, an increase on CN¥511.2m, over one year. However, its balance sheet shows it holds CN¥24.1b in cash, so it actually has CN¥23.4b net cash.

A Look At China Communications Services' Liabilities

According to the last reported balance sheet, China Communications Services had liabilities of CN¥55.2b due within 12 months, and liabilities of CN¥2.07b due beyond 12 months. On the other hand, it had cash of CN¥24.1b and CN¥39.9b worth of receivables due within a year. So it actually has CN¥6.68b more liquid assets than total liabilities.

This surplus liquidity suggests that China Communications Services' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, China Communications Services boasts net cash, so it's fair to say it does not have a heavy debt load!

China Communications Services's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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, a company can only pay off debt with cold hard cash, not accounting profits. 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. Over the last three years, China Communications Services actually produced more free cash flow than EBIT. 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¥23.4b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥1.9b, being 109% of its EBIT. So we don't think China Communications Services's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for China Communications Services you should know about.

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. 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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