COFCO Joycome Foods (HKG:1610) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 COFCO Joycome Foods Limited (HKG:1610) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for COFCO Joycome Foods

What Is COFCO Joycome Foods's Debt?

The image below, which you can click on for greater detail, shows that COFCO Joycome Foods had debt of CN¥6.27b at the end of June 2021, a reduction from CN¥13.7b over a year. However, it does have CN¥1.10b in cash offsetting this, leading to net debt of about CN¥5.17b.

A Look At COFCO Joycome Foods' Liabilities

According to the last reported balance sheet, COFCO Joycome Foods had liabilities of CN¥8.46b due within 12 months, and liabilities of CN¥947.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.10b as well as receivables valued at CN¥1.26b due within 12 months. So its liabilities total CN¥7.05b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥9.78b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

COFCO Joycome Foods's net debt is only 0.93 times its EBITDA. And its EBIT easily covers its interest expense, being 72.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, COFCO Joycome Foods grew its EBIT by 37% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if COFCO Joycome Foods 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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last two years, COFCO Joycome Foods reported free cash flow worth 7.9% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Both COFCO Joycome Foods's ability to to cover its interest expense with its EBIT and its EBIT growth rate gave us comfort that it can handle its debt. Having said that, its conversion of EBIT to free cash flow somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that COFCO Joycome Foods is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Be aware that COFCO Joycome Foods is showing 5 warning signs in our investment analysis , and 1 of those is potentially serious...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.

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