Here's Why China Oriented International Holdings (HKG:1871) Can Manage Its Debt Responsibly

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.' 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 Oriented International Holdings Limited (HKG:1871) does carry debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for China Oriented International Holdings

What Is China Oriented International Holdings's Debt?

The image below, which you can click on for greater detail, shows that China Oriented International Holdings had debt of CN¥36.8m at the end of December 2020, a reduction from CN¥50.2m over a year. However, it does have CN¥167.6m in cash offsetting this, leading to net cash of CN¥130.8m.

A Look At China Oriented International Holdings' Liabilities

The latest balance sheet data shows that China Oriented International Holdings had liabilities of CN¥99.4m due within a year, and liabilities of CN¥5.97m falling due after that. Offsetting this, it had CN¥167.6m in cash and CN¥7.78m in receivables that were due within 12 months. So it can boast CN¥70.0m more liquid assets than total liabilities.

This surplus strongly suggests that China Oriented International Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that China Oriented International Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Importantly, China Oriented International Holdings's EBIT fell a jaw-dropping 82% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is China Oriented International Holdings'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. China Oriented International Holdings 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. During the last three years, China Oriented International Holdings produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case China Oriented International Holdings has CN¥130.8m in net cash and a decent-looking balance sheet. So we are not troubled with China Oriented International Holdings's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for China Oriented International Holdings (of which 1 is significant!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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