Is Ajisen (China) Holdings (HKG:538) Using Too Much 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.' 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. We can see that Ajisen (China) Holdings Limited (HKG:538) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Ajisen (China) Holdings

What Is Ajisen (China) Holdings's Debt?

The image below, which you can click on for greater detail, shows that Ajisen (China) Holdings had debt of CN¥40.2m at the end of June 2023, a reduction from CN¥79.3m over a year. However, it does have CN¥1.58b in cash offsetting this, leading to net cash of CN¥1.54b.

How Healthy Is Ajisen (China) Holdings' Balance Sheet?

According to the last reported balance sheet, Ajisen (China) Holdings had liabilities of CN¥548.0m due within 12 months, and liabilities of CN¥400.5m due beyond 12 months. On the other hand, it had cash of CN¥1.58b and CN¥72.5m worth of receivables due within a year. So it can boast CN¥702.2m more liquid assets than total liabilities.

This luscious liquidity implies that Ajisen (China) Holdings' balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Ajisen (China) Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Ajisen (China) Holdings made a loss at the EBIT level, last year, it was also good to see that it generated CN¥50m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ajisen (China) Holdings will need earnings to service that debt. 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 company can only pay off debt with cold hard cash, not accounting profits. While Ajisen (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, Ajisen (China) Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Ajisen (China) Holdings has CN¥1.54b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 833% of that EBIT to free cash flow, bringing in CN¥418m. So is Ajisen (China) Holdings's debt a risk? It doesn't seem so to us. 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 1 warning sign for Ajisen (China) Holdings you should know about.

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.