Cabbeen Fashion (HKG:2030) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Cabbeen Fashion Limited (HKG:2030) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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, 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.

Check out our latest analysis for Cabbeen Fashion

What Is Cabbeen Fashion's Debt?

The image below, which you can click on for greater detail, shows that Cabbeen Fashion had debt of CN¥272.3m at the end of June 2021, a reduction from CN¥375.9m over a year. However, it does have CN¥648.1m in cash offsetting this, leading to net cash of CN¥375.8m.

How Strong Is Cabbeen Fashion's Balance Sheet?

The latest balance sheet data shows that Cabbeen Fashion had liabilities of CN¥605.2m due within a year, and liabilities of CN¥228.9m falling due after that. Offsetting this, it had CN¥648.1m in cash and CN¥572.6m in receivables that were due within 12 months. So it can boast CN¥386.6m more liquid assets than total liabilities.

It's good to see that Cabbeen Fashion has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Cabbeen Fashion has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Cabbeen Fashion grew its EBIT by 13% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is Cabbeen Fashion's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Cabbeen Fashion 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. Looking at the most recent three years, Cabbeen Fashion recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Cabbeen Fashion has net cash of CN¥375.8m, as well as more liquid assets than liabilities. And it also grew its EBIT by 13% over the last year. So is Cabbeen Fashion's debt a risk? It doesn't seem so to us. 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 instance, we've identified 3 warning signs for Cabbeen Fashion (1 doesn't sit too well with us) 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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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.
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