We Think Meituan (HKG:3690) Can Manage Its Debt With Ease

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.' 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. As with many other companies Meituan (HKG:3690) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Meituan

What Is Meituan's Debt?

The image below, which you can click on for greater detail, shows that Meituan had debt of CN¥37.5b at the end of June 2024, a reduction from CN¥54.0b over a year. However, its balance sheet shows it holds CN¥133.3b in cash, so it actually has CN¥95.8b net cash.

A Look At Meituan's Liabilities

The latest balance sheet data shows that Meituan had liabilities of CN¥94.3b due within a year, and liabilities of CN¥30.8b falling due after that. Offsetting this, it had CN¥133.3b in cash and CN¥10.7b in receivables that were due within 12 months. So it can boast CN¥18.9b more liquid assets than total liabilities.

This short term liquidity is a sign that Meituan could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Meituan boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Meituan grew its EBIT by 250% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Meituan can strengthen its balance sheet over time. 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. Meituan 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. Happily for any shareholders, Meituan actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Meituan has CN¥95.8b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 272% of that EBIT to free cash flow, bringing in CN¥36b. So is Meituan'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. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Meituan that you should be aware of.

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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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.