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. We note that 361 Degrees International Limited (HKG:1361) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.
How Much Debt Does 361 Degrees International Carry?
As you can see below, 361 Degrees International had CN¥208.6m of debt at June 2021, down from CN¥2.38b a year prior. But on the other hand it also has CN¥4.97b in cash, leading to a CN¥4.76b net cash position.
A Look At 361 Degrees International's Liabilities
According to the last reported balance sheet, 361 Degrees International had liabilities of CN¥2.26b due within 12 months, and liabilities of CN¥22.6m due beyond 12 months. Offsetting this, it had CN¥4.97b in cash and CN¥2.81b in receivables that were due within 12 months. So it actually has CN¥5.50b 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.
Another good sign is that 361 Degrees International has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. 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'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 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. In the last three years, 361 Degrees International's free cash flow amounted to 39% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that 361 Degrees International has net cash of CN¥4.76b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 27% over the last year. So we don't think 361 Degrees International's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in 361 Degrees International, you may well want to click here to check an interactive graph of its earnings per share history.
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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