We Think Cosmo Lady (China) Holdings (HKG:2298) Can Stay On Top Of Its 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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Cosmo Lady (China) Holdings Company Limited (HKG:2298) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Cosmo Lady (China) Holdings

How Much Debt Does Cosmo Lady (China) Holdings Carry?

As you can see below, at the end of June 2023, Cosmo Lady (China) Holdings had CN¥436.6m of debt, up from CN¥360.4m a year ago. Click the image for more detail. But it also has CN¥1.04b in cash to offset that, meaning it has CN¥603.6m net cash.

How Strong Is Cosmo Lady (China) Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cosmo Lady (China) Holdings had liabilities of CN¥1.17b due within 12 months and liabilities of CN¥348.0m due beyond that. Offsetting this, it had CN¥1.04b in cash and CN¥316.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥163.1m.

Cosmo Lady (China) Holdings has a market capitalization of CN¥438.6m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Cosmo Lady (China) Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Notably, Cosmo Lady (China) Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥48m in the last twelve months. 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 Cosmo Lady (China) Holdings'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 Cosmo Lady (China) Holdings 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 year, Cosmo Lady (China) Holdings 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

Although Cosmo Lady (China) Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥603.6m. And it impressed us with free cash flow of CN¥52m, being 109% of its EBIT. So we don't have any problem with Cosmo Lady (China) Holdings's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Cosmo Lady (China) Holdings has 2 warning signs we think you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.