Is China Communications Services (HKG:552) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China Communications Services

What Is China Communications Services's Debt?

The image below, which you can click on for greater detail, shows that at December 2021 China Communications Services had debt of CN¥812.8m, up from CN¥704.4m in one year. However, its balance sheet shows it holds CN¥24.5b in cash, so it actually has CN¥23.7b net cash.

How Healthy Is China Communications Services' Balance Sheet?

The latest balance sheet data shows that China Communications Services had liabilities of CN¥58.3b due within a year, and liabilities of CN¥2.10b falling due after that. Offsetting this, it had CN¥24.5b in cash and CN¥39.8b in receivables that were due within 12 months. So it actually has CN¥3.91b 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. 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 fact China Communications Services's saving grace is its low debt levels, because its EBIT has tanked 42% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 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 company can only pay off debt with cold hard cash, not accounting profits. 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¥23.7b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 144% of that EBIT to free cash flow, bringing in CN¥4.5b. So we don't think China Communications Services's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for China Communications Services that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.