We Think Want Want China Holdings (HKG:151) Can Manage Its Debt With Ease

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Want Want China Holdings Limited (HKG:151) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Want Want China Holdings

What Is Want Want China Holdings's Debt?

As you can see below, Want Want China Holdings had CN¥10.2b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has CN¥17.3b in cash, leading to a CN¥7.12b net cash position.

A Look At Want Want China Holdings's Liabilities

The latest balance sheet data shows that Want Want China Holdings had liabilities of CN¥12.0b due within a year, and liabilities of CN¥3.84b falling due after that. Offsetting this, it had CN¥17.3b in cash and CN¥933.6m in receivables that were due within 12 months. So it actually has CN¥2.42b more liquid assets than total liabilities.

This surplus suggests that Want Want China Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Want Want China Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Want Want China Holdings grew its EBIT at 10% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Want Want China Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 90% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Want Want China Holdings has net cash of CN¥7.12b, as well as more liquid assets than liabilities. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in CN¥4.6b. So is Want Want China Holdings's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Want Want China Holdings that you should be aware of before investing here.

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. 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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