Does COFCO Joycome Foods (HKG:1610) Have A Healthy Balance Sheet?

Warren Buffett famously said, '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. As with many other companies COFCO Joycome Foods Limited (HKG:1610) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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.

See our latest analysis for COFCO Joycome Foods

How Much Debt Does COFCO Joycome Foods Carry?

The image below, which you can click on for greater detail, shows that at June 2022 COFCO Joycome Foods had debt of CN¥8.51b, up from CN¥6.27b in one year. However, it also had CN¥1.02b in cash, and so its net debt is CN¥7.49b.

How Healthy Is COFCO Joycome Foods' Balance Sheet?

We can see from the most recent balance sheet that COFCO Joycome Foods had liabilities of CN¥11.3b falling due within a year, and liabilities of CN¥742.1m due beyond that. Offsetting this, it had CN¥1.02b in cash and CN¥2.18b in receivables that were due within 12 months. So its liabilities total CN¥8.85b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥7.01b, we think shareholders really should watch COFCO Joycome Foods's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.17 times and a disturbingly high net debt to EBITDA ratio of 15.0 hit our confidence in COFCO Joycome Foods like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, COFCO Joycome Foods's EBIT was down 100% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine COFCO Joycome Foods'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, COFCO Joycome Foods actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

To be frank both COFCO Joycome Foods's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And furthermore, its level of total liabilities also fails to instill confidence. Considering all the factors previously mentioned, we think that COFCO Joycome Foods really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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 - COFCO Joycome Foods 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. 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.