Chinese People Holdings (HKG:681) Seems To Use Debt Rather Sparingly

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Chinese People Holdings Company Limited (HKG:681) 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Chinese People Holdings

What Is Chinese People Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Chinese People Holdings had CN¥99.4m of debt in December 2020, down from CN¥131.7m, one year before. But it also has CN¥614.9m in cash to offset that, meaning it has CN¥515.5m net cash.

How Healthy Is Chinese People Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chinese People Holdings had liabilities of CN¥636.6m due within 12 months and liabilities of CN¥73.7m due beyond that. Offsetting these obligations, it had cash of CN¥614.9m as well as receivables valued at CN¥250.8m due within 12 months. So it can boast CN¥155.3m more liquid assets than total liabilities.

This surplus liquidity suggests that Chinese People Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Chinese People Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Chinese People Holdings grew its EBIT at 13% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is Chinese People 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Chinese People 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 most recent three years, Chinese People Holdings recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Chinese People Holdings has CN¥515.5m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥177m, being 77% of its EBIT. So we don't think Chinese People Holdings's use of debt is risky. 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. For example - Chinese People Holdings has 2 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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