Is Tsingtao Brewery (HKG:168) Using Too Much Debt?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Tsingtao Brewery Company Limited (HKG:168) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Tsingtao Brewery

What Is Tsingtao Brewery's Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Tsingtao Brewery had debt of CN¥743.8m, up from CN¥698.2m in one year. But on the other hand it also has CN¥19.8b in cash, leading to a CN¥19.0b net cash position.

How Strong Is Tsingtao Brewery's Balance Sheet?

According to the last reported balance sheet, Tsingtao Brewery had liabilities of CN¥17.6b due within 12 months, and liabilities of CN¥4.41b due beyond 12 months. On the other hand, it had cash of CN¥19.8b and CN¥830.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.40b.

Having regard to Tsingtao Brewery's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥103.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Tsingtao Brewery also has more cash than debt, so we're pretty confident it can manage its debt safely.

While Tsingtao Brewery doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 Tsingtao Brewery'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 company can only pay off debt with cold hard cash, not accounting profits. While Tsingtao Brewery has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Tsingtao Brewery actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Tsingtao Brewery has CN¥19.0b in net cash. And it impressed us with free cash flow of CN¥2.8b, being 142% of its EBIT. So we don't think Tsingtao Brewery's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Tsingtao Brewery that 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.