We Think China Dongxiang (Group) (HKG:3818) Can Manage Its Debt With Ease

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, China Dongxiang (Group) Co., Ltd. (HKG:3818) does carry debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for China Dongxiang (Group)

What Is China Dongxiang (Group)'s Debt?

The chart below, which you can click on for greater detail, shows that China Dongxiang (Group) had CN¥177.8m in debt in September 2020; about the same as the year before. However, its balance sheet shows it holds CN¥5.54b in cash, so it actually has CN¥5.36b net cash.

How Strong Is China Dongxiang (Group)'s Balance Sheet?

According to the last reported balance sheet, China Dongxiang (Group) had liabilities of CN¥822.4m due within 12 months, and liabilities of CN¥355.1m due beyond 12 months. On the other hand, it had cash of CN¥5.54b and CN¥642.4m worth of receivables due within a year. So it actually has CN¥5.00b more liquid assets than total liabilities.

This surplus liquidity suggests that China Dongxiang (Group)'s balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, China Dongxiang (Group) boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that China Dongxiang (Group) has boosted its EBIT by 77%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China Dongxiang (Group)'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. China Dongxiang (Group) 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. Over the last three years, China Dongxiang (Group) saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case China Dongxiang (Group) has CN¥5.36b in net cash and a strong balance sheet. And we liked the look of last year's 77% year-on-year EBIT growth. So we don't think China Dongxiang (Group)'s use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for China Dongxiang (Group) (of which 1 is potentially serious!) you should know about.

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. 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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