Is Want Want China Holdings (HKG:151) A Risky Investment?

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.' 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 Want Want China Holdings Limited (HKG:151) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for Want Want China Holdings

How Much Debt Does Want Want China Holdings Carry?

As you can see below, Want Want China Holdings had CN¥6.12b of debt at September 2022, down from CN¥8.24b a year prior. However, it does have CN¥8.66b in cash offsetting this, leading to net cash of CN¥2.54b.

How Healthy Is Want Want China Holdings' Balance Sheet?

We can see from the most recent balance sheet that Want Want China Holdings had liabilities of CN¥8.62b falling due within a year, and liabilities of CN¥3.41b due beyond that. Offsetting these obligations, it had cash of CN¥8.66b as well as receivables valued at CN¥950.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.42b.

Of course, Want Want China Holdings has a market capitalization of CN¥54.8b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Want Want China Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Want Want China Holdings's EBIT dived 19%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Want Want China Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Want Want China Holdings 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, Want Want China Holdings generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

We could understand if investors are concerned about Want Want China Holdings's liabilities, but we can be reassured by the fact it has has net cash of CN¥2.54b. And it impressed us with free cash flow of CN¥3.4b, being 84% of its EBIT. So we are not troubled with Want Want China Holdings's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Want Want 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.