361 Degrees International (HKG:1361) Seems To Use Debt Quite Sensibly

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.' 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. Importantly, 361 Degrees International Limited (HKG:1361) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for 361 Degrees International

What Is 361 Degrees International's Debt?

The image below, which you can click on for greater detail, shows that 361 Degrees International had debt of CN¥1.94b at the end of December 2020, a reduction from CN¥2.53b over a year. However, it does have CN¥6.45b in cash offsetting this, leading to net cash of CN¥4.51b.

A Look At 361 Degrees International's Liabilities

Zooming in on the latest balance sheet data, we can see that 361 Degrees International had liabilities of CN¥4.04b due within 12 months and liabilities of CN¥14.4m due beyond that. Offsetting these obligations, it had cash of CN¥6.45b as well as receivables valued at CN¥2.34b due within 12 months. So it actually has CN¥4.73b more liquid assets than total liabilities.

This surplus liquidity suggests that 361 Degrees International's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that 361 Degrees International has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, 361 Degrees International's EBIT dived 17%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine 361 Degrees International's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While 361 Degrees International 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. Looking at the most recent three years, 361 Degrees International recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case 361 Degrees International has CN¥4.51b in net cash and a strong balance sheet. So we are not troubled with 361 Degrees International's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for 361 Degrees International you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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