Health Check: How Prudently Does Xiabuxiabu Catering Management (China) Holdings (HKG:520) Use Debt?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Xiabuxiabu Catering Management (China) Holdings Co., Ltd. (HKG:520) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Xiabuxiabu Catering Management (China) Holdings

What Is Xiabuxiabu Catering Management (China) Holdings's Debt?

The image below, which you can click on for greater detail, shows that Xiabuxiabu Catering Management (China) Holdings had debt of CN¥58.7m at the end of December 2022, a reduction from CN¥75.8m over a year. But on the other hand it also has CN¥590.9m in cash, leading to a CN¥532.2m net cash position.

How Strong Is Xiabuxiabu Catering Management (China) Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Xiabuxiabu Catering Management (China) Holdings had liabilities of CN¥1.77b due within 12 months and liabilities of CN¥1.01b due beyond that. Offsetting these obligations, it had cash of CN¥590.9m as well as receivables valued at CN¥73.2m due within 12 months. So its liabilities total CN¥2.12b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Xiabuxiabu Catering Management (China) Holdings is worth CN¥5.51b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Xiabuxiabu Catering Management (China) Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Xiabuxiabu Catering Management (China) Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Xiabuxiabu Catering Management (China) Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥4.7b, which is a fall of 23%. That makes us nervous, to say the least.

So How Risky Is Xiabuxiabu Catering Management (China) Holdings?

Although Xiabuxiabu Catering Management (China) Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥480m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. For riskier companies like Xiabuxiabu Catering Management (China) Holdings I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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.