Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘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. As with many other companies Jiashili Group Limited (HKG:1285) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. 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.
What Is Jiashili Group’s Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Jiashili Group had debt of CN¥487.2m, up from CN¥376.9m in one year. However, its balance sheet shows it holds CN¥556.5m in cash, so it actually has CN¥69.3m net cash.
How Strong Is Jiashili Group’s Balance Sheet?
According to the last reported balance sheet, Jiashili Group had liabilities of CN¥820.0m due within 12 months, and liabilities of CN¥200.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥556.5m as well as receivables valued at CN¥149.2m due within 12 months. So it has liabilities totalling CN¥315.0m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Jiashili Group has a market capitalization of CN¥525.3m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Jiashili Group also has more cash than debt, so we’re pretty confident it can manage its debt safely.
In addition to that, we’re happy to report that Jiashili Group has boosted its EBIT by 31%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Jiashili Group’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Jiashili Group 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, Jiashili Group produced sturdy free cash flow equating to 57% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Although Jiashili Group’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¥69.3m. And we liked the look of last year’s 31% year-on-year EBIT growth. So we are not troubled with Jiashili Group’s debt use. Given Jiashili Group has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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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