Haidilao International Holding (HKG:6862) Takes On Some Risk With Its Use Of Debt

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Haidilao International Holding Ltd. (HKG:6862) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Haidilao International Holding

What Is Haidilao International Holding's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Haidilao International Holding had CN¥7.03b of debt in June 2022, down from CN¥7.73b, one year before. However, it does have CN¥7.34b in cash offsetting this, leading to net cash of CN¥306.9m.

A Look At Haidilao International Holding's Liabilities

Zooming in on the latest balance sheet data, we can see that Haidilao International Holding had liabilities of CN¥8.51b due within 12 months and liabilities of CN¥10.1b due beyond that. Offsetting these obligations, it had cash of CN¥7.34b as well as receivables valued at CN¥1.47b due within 12 months. So its liabilities total CN¥9.82b more than the combination of its cash and short-term receivables.

Since publicly traded Haidilao International Holding shares are worth a total of CN¥67.2b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Haidilao International Holding also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, Haidilao International Holding's EBIT fell a jaw-dropping 99% 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 ultimately the future profitability of the business will decide if Haidilao International Holding 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Haidilao International Holding 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, Haidilao International Holding burned a lot of cash. 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

Although Haidilao International Holding's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥306.9m. Despite its cash we think that Haidilao International Holding seems to struggle to grow its EBIT, so we are wary of the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Haidilao International Holding .

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. 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.